Gretchen Tai Thinks There's Benefit in Being Dynamic

From aiCIO Magazine's Fall 2011 Issue: Tai, who together with her investment team oversees upward of $35 billion in defined benefit (DB) and defined contribution (DC) assets scattered around the globe, spoke with aiCIO on Hewlett-Packard's well-timed liability-driven investing (LDi) move, as well as the rigors of managing DB alongside DC.  

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“To be honest, we weren’t timing the market. HP had decided to freeze the U.S. DB plan, which at the time was 106% funded and, as a result, we decided with our senior management that an immunization strategy was the right strategy going forward even with pension expense considerations; so, in November 2007, we decided to move out of public equities and into fixed-income and hedged out interest-rate exposure 100%. Although it wasn’t our main consideration, timing of the strategy was fortunate: We were not only able to maintain our funding status through the financial crisis, but also it improved significantly due to strong returns from fixed-income portfolios as well as the interest-rate hedges. The lesson is this: Don’t get greedy, take risk off the table when you can. Many funds were better funded than us. It wasn’t an easy decision (to shift assets and immunize), but it was the right decision. Since then, we’ve acquired EDS and their pension plans. The EDS pension plan didn’t execute LDI, and it hadn’t emerged from the crisis as well as the HP plan, so what we did was combine the two plans and re-risked the merged plan since the combined plan is less than fully funded. What we’re doing now is LDI 2.0—it’s an enhancement over what we did before. Instead of waiting for the combined plan to be fully funded, we now dynamically adjust our risk budget as our funded status changes: less risk as we approach fully funded and more risk if the funded status falls. We look at the two largest sources of risk—equity and interest rate—and we use derivative-based strategies to be dynamic. Derivatives let you be flexible and have lower transaction costs than using physical assets. It’s not desirable nor practical to move into and out of physical assets frequently. On equity exposure, ours depends on the funding status—as funding improves, equity risk is taken off the table gradually. On the interest rate exposure, however, our interest rate hedge ratio is based on funded status and yield levels. It’s a two-dimensional approach—we think it’s unique. Outside of the U.S., HP began pooling pension assets in 2010 so that we can manage our pension assets more efficiently and effectively. We also manage the company’s DC plan. HP again is being really progressive here. Marketwide, defined benefit plan returns are so much better than defined contribution returns in historical performance—mostly because you have professionals looking after DB assets, and not looking after DC plans. With $15 billion in U.S. 401(k) assets, however, we really want a fresh eye on the plan—we want it to be world class. To do this, we’ve tried to eliminate mutual funds from the investment options, to lower fees. You won’t see brand name mutual funds in our plans—we want participants to focus much more on asset allocation decisions than picking mutual fund managers. Because our plan is so large, we often can use a custom fund-of-funds approach for each offering—which allows our participants to get the benefits of diversification without doing a lot of work.”

aiCIO Editorial Staff