STRATEGY + TACTICS
the LDI manager allocates more of the
portfolio to long-duration fixed-income to
more precisely match the plan’s liabilities.
“The early stage de-risking is just
extending duration. The late-stage de-risking
is to precisely match the liability. It’s able to be
done gradually by most plans,” he said.
A second way to execute a de-risking
strategy is over time, especially if a plan
sponsor will commit cash to make the plan
fully funded, he said. That’s where each
year the sponsor looks at the size of the
plan’s unfunded liability and makes contributions that will lead to a fully funded status
at the end of a specified period of time, typically over several years.
Wilson explained how he is working with
Essentia Health’s $225 million pension plan
to ensure full funding within 10 years (and not
simply waiting for interest rates to rise). “They
deemed LDI as the most effective de-risking
tool available to corporate plan sponsors,
and the time-based component alleviated the
need to wait for rates to rise,” he said.
After conducting a comprehensive
risk analysis for the plan, Nuveen partnered with Essentia Health’s chief investment officer and their investment consultant to develop a time-based glidepath and
ongoing risk framework.
Wilson said the strategy created a
structural discipline regarding investment
risk and contributions, and maximizes the
probability of meeting their funded ratio
target and risk goals.
“We are in year two of a 10-year
strategy. We actively monitor the plan
and progress along the glide path. We also
deliver a customized client dashboard to
the client on a quarterly basis in addition to
managing the bond investments,” he said.
If the plan sponsor of a closed plan will
commit corporate cash to the pension fund
over a period of time, it may not need to take
much investment risk at all, Dutton observed.
“In my mind that makes the case for
a lower-risk investment strategy stronger,”
But there’s a trade-off for plan sponsors wanting to put more money into their
plans versus reinvestment in the company
itself, Dasher said, and this needs serious
contemplation. “[ This is] probably the most
important thing for any company to think
about—the trade-off between the capital
that they can invest in their business versus
adding more certainly to the pension-fund
line item,” he said.
How much a pension plan hedges its
funding status risk with its investments
will depend on a plan sponsor’s risk toler-
ance and time horizon, Dutton said. When
determining an investment strategy, there’s
a split in the portfolio between return-
seeking assets (equities or alternative assets,)
and the liability-hedging side, (bonds meant
to offset the interest-rate risk in the liability.)
A sponsor with a high degree of risk
tolerance may use 60% or 70% return-
seeking assets, but that figure could fall to
as little as 20% or 10%, and perhaps not
include any equities in the portfolio, if the
sponsor has a very short time horizon, low
risk tolerance, or a well-funded plan, he said.
Nili believes that, at a minimum, most
plans should be at least 50% interest-rate
hedged and there’s a strong case for a higher
percentage hedge for more fully-funded plans.
“As a plan progresses down the glide
path, those ratios should approach 100%,”
Plans should look to long government or
corporate credit when matching liabilities,
Nili said. One way plans may increase duration without changing their portfolio significantly is to incorporate Treasury STRIPS,
which is becoming more popular for plans
on a glide path.
Wilson said a mix of Treasury and
corporate bonds can be good vehicles for
plans looking to de-risk and boost duration.
The Nuveen Pension Investment Indexes
uses a mix of intermediate and long-duration corporate bonds, along with the ultra-long Treasury STRIPS, which have a duration of about 26 years.
“You match the liability as best you
can with the corporate bonds indexes, and
you use the STRIPS for the necessary duration,” he said. —Debbie Carlson
Type of LDI Strategies Respondents Said They Were Employing
n 2012 n 2015
Source: Bloomberg Barclays US Long Government/Credit Index, Vanguard; Citigroup Intermediate Pension Liability Index, Vanguard for Sample pension liability
Phase derisking Interest rate hedging Bond immunization/
cash flow matching
Hit funding trigger? 39%
Took action? 95%