CIO: The current U.S. economic expansion is getting old; it’s
already the third longest since 1854. What are some of the
biggest challenges and opportunities defined benefit plans
will face when the economic cycle starts to turn?
David Wilson: Unfortunately, there will be more challenges than
opportunities, in my view. The persistently low interest-rate environment is the biggest challenge corporate pension plans have faced
since 2008 because it’s increased the value of their liabilities while
simultaneously dampening future expected returns on fixed-income
portfolios. We don’t see that changing for quite some time. Looking
specifically at corporate pension plans, most still have large allocations to global equities, and when the economic cycle turns down,
equity prices typically fall. Given that corporate plans are already
underfunded—the average plan had an 82% funded ratio at the
end of September—this could present another major challenge.
Public pension plans are not as impacted by interest rates as corporate plans, at least on the liability side, since their liability discount
rate is fairly static. But on the asset side, many plans have reduced
their fixed income allocations due to the low rate environment and
fears that we will enter into a rising rate environment. They face even
greater challenges with respect to a future downturn in equity prices.
CIO: Why would an equity market downturn hit public plans
harder than corporate plans?
Wilson: Public plans typically invest about 75% of their assets in
CIO: Let’s focus on corporate plans for a moment. A lot of
return-seeking strategies like equities and alternatives, which is a good
bit more than the average corporate plan. So they’re taking on more
investment risk. They also are far more underfunded. According to a
recent survey, the average public plan had a 71% funded ratio in 2016
using a liability discount rate of 7.5%. Compare that to the average
corporate plan that’s 82% funded with about a 4% discount rate, and
you can see that public plans are in a very different economic situation.
For both types of plans, though, the headline message is that with
potentially more challenges than opportunities on the horizon, it is
vital that they protect their investment portfolios using sophisticated
them have been trying to de-risk for years, primarily through
some form of liability-driven investing. Why hasn’t this led to
improved funding ratios?
WIlson: Beginning in 2008, long-term interest rates started going
lower and then stayed low, historically low actually, so many plans
weren’t able to make progress on their de-risking glide path. They
weren’t able to hit their glide-path triggers because falling rates
boosted the value of their liability. Then, in 2014, mortality tables
were updated, which caused their liability to rise again, and their
funded ratio just continued to struggle, despite generally increased
contributions and strong investment returns.
CIO: Do you see better results from liability-driven investing
Wilson: I think corporate plan sponsors will generally be disappointed
Photograph by Nathan Weber SPONSORED SECTION
Eight years of nearly uninterrupted economic growth and stock
market gains have barely made a dent in the funded status of U.S.
corporate and public pension plans. We may now be approaching an
inflection point: most analysts agree the current economic expansion
is in its later stages, and the Federal Reserve has begun to unwind
the extraordinary measures it took in the wake of the 2008 financial
crisis to bolster the economy. Chief Investment Officer spoke recently
with David Wilson, head of Nuveen Asset Management’s Institutional
Solutions Group, to find out what the potential ramifications are for
plan sponsors as the economic climate changes, and why corporate
and public plans may need to respond differently.
Traditional approaches to de-risking DB plans
haven’t yielded the desired results