Many DB plans concentrate their risk in two positions: They
are long equities and significantly underhedged versus their
liabilities. As a result, the key market forces that affect their
funded status are equity returns and interest rates. We used
those two variables to define the four economic scenarios shown
below. Clear Skies is the optimal scenario: With equity returns
and rates rising, both risk positions would be expected to pay
off. But this environment has prevailed only a quarter of the
time since 1973.1
• Low equity beta
• Some interest-rate sensitivity
Long equity and underhedged liability
Unconstrained or credit-oriented
;xed income strategies
Interest rates Down
For illustrative purposes only. Not intended as investment advice.
The polar opposite of that scenario is a Perfect Storm, where
falling equity returns and falling rates can threaten major
funded status drawdowns. Ideally, plans would have minimal
equity risk and fully hedge their liabilities to produce steady
liability-relative returns in all environments (especially a Perfect
Storm). But that might be unrealistic for those that desire some
return to help offset costs and improve funded status.
We think plans that still desire some return above their
liability can mitigate the risk of a Perfect Storm by diversifying
their return-seeking portfolio with “bridge strategies” —
investments that combine return-seeking and liability-matching
characteristics, and that may offer low equity beta and moderate
interest-rate sensitivity (duration). Examples include liquid
infrastructure investments and unconstrained or credit-
oriented fixed income strategies. We advocate holding a mix of
bridge strategies that encompass varying levels of equity beta
and rate sensitivity. This provides diversification and may better
balance the portfolio across the Partly Sunny/Cloudy scenarios,
in which equity returns and interest rates move in opposite
directions. In these environments, the effect on funded status
depends on which of the two variables dominates. Our research
confirms that during periods when equity returns and interest
rates have moved in opposite directions, traditional equity
exposure has been about equally as likely to harm plan funded
ratios as to improve them.
It is this uncertainty about what will work best in a Partly
Sunny/Cloudy scenario that argues for a mix of bridge strategies.
For example, in Partly Sunny scenarios, liquid infrastructure
investments may have enough market beta to participate in
rising equity markets, and may benefit from falling rates given
their interest-rate sensitivity. In Partly Cloudy scenarios,
unconstrained or credit-oriented fixed income strategies may
be attractive for their low equity beta, even with modest rate
sensitivity. Absolute return strategies may also help plans
navigate different environments. Whether using stand-alone or
portable alpha strategies, the key is ensuring that the returns
are truly market neutral.
While these approaches might give up some upside relative to
traditional equities in Clear Skies, we expect they would still
outperform the liability and contribute to funded ratio improvement.
Regardless of the specific strategies selected, the focus should be
on taking a more holistic approach to return-seeking assets that
doesn’t count on ideal conditions for its success.
Amy Morse, Director of Pension Strategies
firstname.lastname@example.org | 1-617-951-5655
FOR CORPORATE DB PLANS, RETURN-SEEKING ASSETS ARE OFTEN SYNONYMOUS WITH TRADITIONAL EQUITIES.
That’s fine if market conditions are just right, but it leaves plans vulnerable in many environments. We think the
solution is to diversify return-seeking allocations with assets that may perform well in a variety of conditions.
Weatherproofing a plan’s return-seeking assets
Amy Trainor, FSA
and LDI Team Co-Chair
FOR INSTITUTIONAL INVESTORS ONLY SPECIAL ADVERTISING SECTION ;;;;;;_;
1March 1973 – December 2016. Equities: S&P 500. Liabilities: 75% Bloomberg Barclays US Long Corporate Bond/25% Bloomberg Barclays US Long Government Bond | Equities up/
down identified by direction of monthly return on S&P 500; up/(down) rates defined as months where yield on US 10-year Treasury rose/(fell) by over 5 bps | PAS T RESULTS ARE NOT
NECESSARILY INDICATIVE OF FU TURE RESULTS AND AN INVES TMENT CAN LOSE VALUE | Sources: S&P, Bloomberg Barclays, US Treasury, Wellington Management
This material and/or its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of
Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Investors should
always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed
herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may
make different investment decisions for different clients.