Seven Key Questions
Plan Sponsors Are Asking
Members of Wellington Management’s LDI team
looked back on more than 100 meetings with
corporate plan sponsors in 2017 and noticed
some consistent themes. Here they tackle seven
questions that were top of mind, with responses
from team Co-Chairs Amy Trainor and Bill Cole,
and LDI Quantitative Strategist Louis Liu.
Why would a plan consider using LDI
today if the plan is underfunded and
rates are low?
TRAINOR: Waiting for rates to rise can actually be costly.
Let me explain. Most plans today are underhedged versus
their liability, with a hedge ratio around 40% − 45% being
fairly typical. There’s an expectation that if rates rise, the
plan’s funded ratio will benefit from being underhedged.
While that should be true if rates rise rapidly over the
short term, it’s less clear that it will be true if it takes
longer for rates to rise.
For example, if rates go up 100 basis points tomorrow or
even over the course of the next year, then it would seem
likely that the typical underhedged plan (again, a hedge
ratio of 40% − 45%) would enjoy a meaningful benefit
to its funded ratio. But if it takes five years for rates to
go up 100 basis points, that same plan’s funded ratio
could actually experience a small decline. While it may
sound counterintuitive that rates could go up but the
funded ratio could decline, this can be chalked up to
the fact that the liability’s yield would have accrued and
compounded over that five-year period, offsetting the
benefit of higher rates.
We think that this can be a useful lens through which
to view the liability-hedging decision: quantifying how
much rates need to go up over a particular time period
in order for a plan’s funded ratio to benefit from being
underhedged. In terms of implementation, one action
step might be to add interest-rate triggers to a plan’s
glidepath—in order to systematically extend duration
and increase the hedge ratio as rates rise. That may help
to avoid the erosion of any funded-ratio gains arising
from short-term rate movements.
Do plans need to customize their
COLE: We think a little bit of customization can go a
long way. Our research suggests that plans may be able
to achieve their desired level of funded-ratio volatility by
blending standard market indexes in a manner that targets
an appropriate level of interest-rate and credit risk. We
have found that a benchmark with 75% long corporate
bonds and 25% long government bonds could suit plans
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Bill Cole, CFA, CAIA
LDI Team Co-Chair,
Amy Trainor, FSA
LDI Team Co-Chair,
and Portfolio Manager
Louis Liu, PhD,
CFA, ASA, MAAA