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.
A cornerstone of our investment approach
We believe that a diversified return-seeking portfolio should complement core equities with:
- Defensive equity strategies that aim to outperform in down equity markets while preserving opportunities for funded-ratio growth. Examples include income-oriented equities, “cash compounder” approaches that invest in companies with high and stable free-cash-flow yields, and low-volatility approaches.
- Diversifiers that seek to provide more explicit downside mitigation in equity sell-offs, such as real estate, infrastructure, net long hedge funds, and return-seeking fixed income.
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.