Spain, Institutional
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Key points
- We believe plan sponsors can seek to minimize funded-ratio volatility by focusing on three key liability risk factors: interest-rate, credit, and yield-curve risk (page 2).
- We think standard market indices can be blended to target all three risks, but that trying to perfectly hedge yield-curve risk can introduce unnecessary cost and complexity (page 5).
- Intermediate corporate bonds may help a liability-hedging benchmark evolve as the liability duration declines, particularly for frozen/mature plans (page 7).
- We believe plans should consider a dynamic approach to liability hedging that takes into account a plan’s overall asset allocation and return-seeking strategy, though a static liability benchmark can also be a fit for some plans (page 9).
- Plans approaching their “end state” may want to consider additional liability-hedging tools, including long-duration securitized assets and taxable municipal bonds (to mitigate issuer concentration and downside risk), intermediate corporate bonds (to expand the opportunity set), and return-seeking fixed income and other strategies that may enhance returns (page 11).
Market conditions in the first quarter of 2021 drove many corporate defined benefit (DB) plans to revisit their liability-hedging allocations and assess new derisking ideas. As we discuss in part one of this paper, our core philosophy for constructing liability-hedging benchmarks remains unchanged. We continue to believe that thoughtful customization tailored to the liability’s key risk drivers goes a long way, but that attempting to perfectly match liability characteristics, especially across the yield curve, can result in unnecessary complexity and costs without a meaningful reduction in funded-ratio volatility.
At the same time, we believe there are a number of opportunities to enhance traditional liability-hedging benchmarks by capitalizing on recent market developments and preparing for the likely effects of future demand in the long-duration fixed income markets. In particular, part two of this paper (beginning on page 11) highlights our research on several allocations that may complement long-duration corporate bonds, including long-duration securitized assets, intermediate corporate bonds, and return-seeking fixed income.
Part one: Our core philosophy for liability-hedging benchmark construction
While every plan has a unique cash flow and demographic profile, we’ve found that traditional (e.g., final average pay) pension liabilities are most sensitive to changes in a few key risk metrics. Specifically, we believe most plans can seek to minimize funded-ratio volatility by managing liability-hedging portfolios benchmarked to a blend of…
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