2017 Liability-Driven Investment Survey

Art by Victo Ngai

A well-known consultant told CIO recently, “To beat the market in the long-term, or to beat your peers, you have to be wrong in the short-term.” When it came to liability- driven investments (LDI), although he was right on disagreeing with market consensus, he lost quite a few clients. Such is the pain of LDI. Yet, according to our annual LDI survey, 2017 respondents saw some painful trends reversing. Average funded ratios are up in every way measured. On a GAAP/PBO basis, (the most popular measurement), funded ratios rose to 91% on average, up from 85% last year.

This may be partially because MAP-21 pension relief has been dwindling: the artificial MAP-21 rates, which allowed employers to defer some pension funding and made pensions seem a bit more funded in the past, have come down, and the expense of having an underfunded pension has increased due to rising Pension Benefit Guaranty Corporation (PBGC) rates.

Subsequently, many have rushed to fund their plans. “For some of our clients, the PBGC premium is their biggest expense, it’s more than their asset management fees, it’s more than their actuarial fees, their administration fees combined,” said Thomas Schatzman, senior vice president and institutional consulting director for Morgan Stanley-Graystone. “And so you get no benefit for that expense, it’s just lost money. It doesn’t help your beneficiaries; you’re just subsidizing poorly funded plans.”

This year also saw a reversal in the trend of more DB plans closing, as 28% are open this year to new entrants versus 17% last year, and 34% are closed to new entrants versus 41% last year. Also, 25% plan to keep their plans open (versus 16% last year) and just 9% plan to close their plans (versus 14% last year). Of our respondents, 64% plan to continue to manage/de-risk (versus 58% last year).

“I definitely see that trend,” said Sean Patton, partner and senior consultant, Westminster Consulting. It is often caused by people closing their plans and heading toward terminations to get the liability off their balance sheet. Many enjoyed good returns this year and are moving their gains away from equities. “But a lot of folks have never implemented LDI or de-risking. So, you’ll probably see some new entrants, you know, implementing LDI or liability-driven investing, or de-risking, for the first time,” he said.

True to form, LDI usage, as a percentage of portfolios, grew from 47% last year to 52% this year. Schatzman believes this was because last year was a good year for funding.

“You had a great market, you had rates bump up 25 basis points or so, and we saw funded statuses increase 5% to 9% for most of our clients.” Some sought to lock down their earnings. “You saw funded statuses increase, which moved people along their glide paths. And we saw more adoptions of fixed-income LDI as a result of the improvement in funded status.”

The gap between liability duration and fixed-income duration has narrowed considerably (this is good because that means fixed-income durations are more in line with actual liabilities). Now the gap is just eight months versus 18 months last year and more than two and a half years in 2011. Perhaps that’s because there had been a classic mismatch of time between a plan’s liabilities and a plan’s fixed-income investments, stemming from the duration of most plans’ liabilities being more than 10 years, and their investments, which are typically in US Core Bond funds, at four- to six-year durations.

Pension investors have been seeking to fix this alignment, turning to long-duration bonds. “That’s where you see this closing of the gap, and moving away from the four- or five-year duration of your traditional US Core Bond portfolio, and out to a longer-duration, government and/or credit bond portfolio,” said Patton. The survey shows hedge ratio has jumped from 48% of portfolios to 56% this year. Investors will have more money into liability matching fixed-income or long bonds, Patton said. —Christine Giordano