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The views expressed are those of the author 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.
Surveying the current market environment, we see a case for reviewing a corporate defined benefit (DB) plan’s return-seeking strategy and considering structural allocations to defensive equities and diversifiers.
We believe that a diversified return-seeking portfolio should complement core equities with:
A plan employing a hypothetical portfolio with equal allocations to core equities, defensive equities, and diversifiers would have ended the 1995 – 2021 period with a funded ratio more than 10% higher than a plan investing its return-seeking portfolio solely in core equities (Figure 1). Why? Better downside mitigation: The diversified portfolio would have captured just 81% of the equity market downside during this period. This was especially valuable in the extreme bear markets of the early 2000s and the global financial crisis, but it also enabled the funded ratio to largely keep pace in up markets, as even in a bull market, equities do not rise consistently upward. In fact, this outperformance occurred despite the diversified portfolio capturing just 85% of the upside in the global equity index over this time period.
We see several reasons to consider a more diversified return-seeking portfolio:
The risk to our view is that is that if we return to the previous environment of low inflation and central bank support, a return-seeking allocation focused on core equities could potentially outperform a more diversified return-seeking allocation. As noted, however, this is not our base case, and given the improved funded status of many plans, we think protecting funded-ratio gains and being prepared for a potential range of outcomes by diversifying the return-seeking allocation is worth considering.
1Current funded ratio estimate as of 26 August 2022. Funded ratios and discount rates estimated by Wellington Management based on change in yields of high-quality corporate bonds (Bloomberg Barclays US Long Credit Aa) since 31 December 2021 and performance of equities (MSCI World), bonds (Bloomberg Barclays US Long Gov/Credit, Bloomberg Barclays US Aggregate), hedge funds (HFRI Fund Weighted Composite Index), and real estate (NCREIF Property Index). Actual results may differ significantly from estimates. Results are presented at the aggregate Russell 3000 Index level. Data is that of a third party. While data is believed to be reliable, no assurance is being provided as to its accuracy or completeness. Sources: FactSet, Wellington Management.
Views expressed are those of the authors, 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. 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. Please consult your own third-party advisers and actuaries before making any investment decisions based on this information.