Home ListingNovember 1, 2013

US Pension Plans’ Route to the Glide Path Endgame

<em>A report has found that most US pension plans are not equipped to face structural changes as they near glide path endgames and improved funding ratios.</em>

Reported by Featured Author

(November 1, 2013) — US corporate pension plans should begin to restructure their investment strategies now to follow the glide path towards “end state” portfolios, according to consultants Hewitt Ennisknupp.

Portfolios near the end state, the report said, shift from return-seeking assets to liability-hedging fixed income securities.

Even though most US corporate plans are still underfunded, many factors such as cash contributions, strong asset performance, and a rise in discount rates, could lead to a steeper de-risking glide path—or an improvement in funded status, the report said. Continued outperformance of equity markets could also push plans towards a sooner end state.

“Preparations for end state pension management should start long before plans reach their end states, thereby ensuring a smooth transition toward a well-planned end goal,” the report said.

Separately, a Redington paper, “Road to the DB End Game,” has expanded upon this phenomenon, claiming that as a plan becomes better funded, “required return”—the liability discount rate plus a buffer to cover risks—will decrease.

This will then allow funds to similarly decrease expected returns and turn to more predictable and less risky investments such as fixed income.

The first step in the transition is determining the plan’s objective—to stay open and maintain its assets or to terminate. Ongoing plans’ longer horizon allows for more freedom in formulating its investment structure, giving plan sponsors greater range in risk budgets. Hewitt EnnisKnupp suggested active management and alternatives for ongoing plans.

For plans headed for termination, their sponsors should focus on building high-quality investment portfolios, Hewitt EnnisKnupp’s report said. The risk budget should be conservative and sponsors should structure the portfolio to draw insurance companies for better pricing on in-kind transfers.

After determining the number of types of portfolios needed based on sponsor preferences, the plan could either form a liability-hedging or a return-seeking portfolio.

A customized liability-hedging portfolio, designed for plan sponsors seeking greater control of assets and liability tracking error, “reflects making specific choices about which aspects of the liabilities (such as interest rate, credit, and yield curve exposures) will be hedged,” the report said.

This can be done in one of three ways: blending various standard fixed income indices that somewhat matches the term structure with liabilities; have managers match the term structure of the liability cash flows and; employ a single “completion manager” to guarantee that the fixed income portfolio has the necessary exposures.

“The key is to balance the increased hedging efficacy of precision with the added cost of a more bespoke portfolio,” the report said.

A return-seeking portfolio for terminating plans would focus mostly on increasing liquidity while those for open plans are allowed greater room for considerable changes to the investment structure.