Strategic Asset Allocation for Corporate Pension Liabilities
Shifting economic trends and fast-evolving market conditions are changing the landscape for corporate pension plans. Plan professionals need to adapt their strategies accordingly, positioning their portfolios to meet future liabilities while managing dynamic risks. Evaluating their asset allocations can help plans invest their assets in the most efficient ways, based on their plans’ specific needs.
Dane Smith, State Street Global Advisors’ managing director and head of investment strategy and research, offers suggestions to help corporate pension plans balance risks and opportunities across their portfolios.
Q: Given the current macroeconomic environment, how should plan sponsors evaluate their asset allocation relative to their liabilities?
Dane Smith: There are a lot of dynamic changes happening in the macroeconomic environment today. The Fed has begun cutting rates, and we're forecasting the potential for as few as 75 basis points of rate cuts next year. This has implications for plan sponsors and their overall asset allocation. Most important is for them to understand whether they are positioned correctly to achieve their return objectives and if they are comfortable with the amount of risk they're taking.
There is a range of outcomes around US DB plans today: Some are well funded, some are overfunded, and some are underfunded and trying to make up ground. For plans that are well funded, we see this as a great opportunity to embrace duration in their portfolio. As they work their way down a derisking glide path, we would hope that they're taking the opportunity to hedge some of the duration risk and credit spread risk in their plan.
For plans that are underfunded, we think diversification is going to be key going forward. Equity market volatility has picked up this year and should continue into 2025. There's no shortage of risks in the market today, ranging from the shift in monetary policy to geopolitical events happening across the globe. For plans that own growth assets, we think diversification will be crucial to manage volatility.
Q: Given the Fed's ongoing efforts to manage inflation and maximize employment, how can well-funded open plans strike a balance between reducing risk and growing their assets?
The term we like to use is capital efficiency. It means the effective deployment of capital or assets to achieve your desired risk and return objectives and characteristics.
What does that mean in practice? For example, say you have a long government-credit allocation in your bond portfolio and you want to bring more assets over to the hedged side of the portfolio: You don't necessarily have to sell equities to do that. You can move assets out of that long government-credit allocation into longer-duration instruments such as STRIPS. You get a bit more duration into your portfolio, and hopefully you reduce some of funding status volatility associated with the duration of your liability relative to the duration of your bond portfolio.
Within your equity assets, if you're going to maintain the same capital allocation, then you should embrace assets in that part of the portfolio that also help reduce funding status volatility and help reduce overall equity beta, which is a big risk to the overall portfolio. Those instruments tend to look like managed volatility equities or bridge assets that contain some upside growth potential but also reduced equity beta.
By focusing on capital efficiency on both sides of the equation, you hope to extend duration, match your liability a little bit more, and keep capital in your higher-returning assets, all while being very mindful of the liability and the overall implication of your assets relative to funding status.
Q: What investment opportunities exist for plan sponsors today that might not be well known?
Dane Smith: Let’s look at the fixed income market, because I think we’re going to continue seeing some easing there over time and eventually create a bit of a tailwind for bond investors. Yields are still at very attractive levels, especially with the most recent backing up in yields
A lesser-known story about the fixed-income market is the number of technological advances that allow investors to access those markets much more efficiently than they once did. Bond markets used to be notorious for being inefficient and opaque. We used to rely on brokers to bring buyers and sellers together to make trades. Now, with the rapid adoption of ETFs with electronic trading across fixed income markets, you no longer need to bring buyers and sellers together in the same way. This shift has created greater pre-trade price transparency and lower execution costs.
Fixed income trading is evolving to be more like equity trading, becoming more data-driven and more conducive to rules-based strategies. This is an opportunity for plan sponsors and liability-aware investors to embrace these advancements and take advantage of them within their overall portfolio by reducing costs while maintaining the potential for outperformance.
Contact your Relationship Manager to learn more about State Street Global Advisors Asset can help corporate plans pursue their investment objectives.