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AS CORPORATE DB PLAN SPONSORS HAVE GRADUALLY SETTLED ON STRATEGIES FOR THEIR LIABILITY-HEDGING ALLOCATIONS AND GLIDEPATHS IN RECENT YEARS, many we’ve spoken with have turned their attention to their return-seeking allocations — and, in particular, how best to structure them to generate funded-ratio growth. Our framework for return-seeking portfolio construction can help plan sponsors think though this decision. The framework emphasizes funded-ratio growth via a more stable path of returns, and it rests on two core philosophical tenets:
- Equities can be a powerful source of funded-ratio growth in some environments but can be less reliable in others.
- Mitigating funded-ratio drawdowns is key to funded-ratio success due to the power of compounding (shallower drawdowns allow assets to recover more quickly).
We therefore approach return-seeking portfolio construction by complementing traditional equity exposure, and its funded-ratio growth potential, with asset classes and strategies that may perform well when equities detract from funded status. In particular, alongside traditional core equities, we emphasize defensive and “bridge” strategies that can potentially outperform core equities in less favorable environments (see box below). These environments include “Perfect Storms,” when a combination of poor equity returns and lower rates can put extreme downward pressure on funded ratios. We believe that balancing exposures to better account for these different environments can help improve the probability of long-term funded-ratio success.
Three building blocks for return-seeking portfolios
Our approach to return-seeking portfolio construction seeks balanced exposure to assets with the potential to perform well across the environments in our “pension weather” framework:
- Return-seeking core — core equity exposure that can take advantage of the best opportunities (“Clear Skies”) to improve funded status
- Return-seeking defensive — equity strategies offering meaningful upside market participation balanced with downside mitigation
- Return-seeking bridge — strategies that aim to provide meaningful downside mitigation when funded ratios are under the most pressure (“Perfect Storms”)
Preparing for sun, storm, and everything in between
Building off this philosophy, our first step in developing a return-seeking framework was to consider how funded ratios tend to behave in different environments, including where they may be most susceptible to…
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