(January 14, 2014) — As corporate pension plans’ funded status reached 95.2% in December 2013, analysts and asset managers have projected big portfolio changes, according to Russell Investments, particularly to liability-driven investing (LDI) strategies,
According to the firm’s funding level analysis, open plans improved 15% and frozen plans 8% last year. Corporate plans with heavy allocations to US equities and “those who made contributions in excess of the value of new benefit accruals” experienced a higher jump in their funded status, the report said.
Analysts maintained that while the extent of such improvement varied from plan to plan, most defined benefit plans found themselves on the upside, with asset allocation changes likely to come in 2014.
“Once a plan is fully funded, there’s all the more reason to avoid investment risk as far as possible, in order to keep it that way,” said Bob Collie, Russell’s chief research strategist for institutions in the Americas.
Many plans will make changes due to liability-responsive asset allocation, or automatic glide paths which systematically decrease risk as funded status improves.
“The rationale for such a policy is essentially that the cost-benefit trade-off changes when plans are fully funded: further upside is less rewarding for a fully funded plan than for an underfunded one,” Collie said.
Even for funds without an automatic reduction of risk in place, many will choose to de-risk, or even turn to LDI strategies, according to Russell.
“Indeed, there was probably a fair amount of pent-up demand for LDI already—but some activity was put on hold due to the unusually low level of interest rates: it has been difficult for some to make significant shifts into long duration fixed income when interest rates have been so low,” Collie said.
Rising interest rates and expected future increases are also expected push corporate plans towards de-risking strategies.
“Unless rates increase faster than the 50 basis points or so that is already priced into the forward curve, investors will still most likely be better off in long bonds,” Collie said. “So, at some point, the pent-up demand for LDI is going to translate into activity as pension plans reduce the very substantial bet they currently have on interest rates.”
The latest escalation in Pension Benefit Guaranty Corp (PBGC) premiums will also play a role in corporate plans’ future allocation changes, Russell said. As plan sponsors move to improve funding status to avoid higher variable rate premiums, they would naturally have to de-risk.
“The recent hike in PBGC variable rate premiums substantially changes the picture for many plans: With shortfalls soon to be penalized at a prohibitive 3% each year, the case for getting a plan to fully funded and implementing a stringent LDI program to keep it that way becomes all the stronger,” the report said.
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