Asset Managers Should Help DB Plans Take Holistic View of Risk

In light of the market volatility in the fourth quarter of 2018, Cerulli set out to gauge the sentiment of mid-sized defined benefit (DB) plans and subsequently issued a white paper, “Derisking DB Plans in Flux.”

While DB plans made tens of billions in contributions in 2018 and also benefitted from higher discount rates, market volatility in the latter part of the year erased many of these gains. And while market conditions improved in the first months of 2019, Cerulli found that mid-sized plans surveyed in the first quarter expressed a greater focus on investment risks and fees paid to third-party asset managers.

Fifty-six percent of these DB sponsors ranked strategic asset allocation advice and risk analytics from investment managers as very important. Cerulli recommends that managers help corporate plans take a more holistic view of investment performance and risk in their portfolios, particularly in the case of asset-liability management.

Cerulli found that in the fourth quarter of 2018, corporate plans held fast. The researcher believes that asset managers and investment consultants working with DB plans should continue to counsel clients on the benefits of improving their plans’ funding status, particularly through liability-driven investing (LDI).

Through September 2018, the average corporate DB plan’s funding status improved from 85% to the low to mid 90s. Many plans, particularly larger ones, had frozen benefit accruals, and due to the September 2018 tax deduction deadline, corporate pension contributions skyrocketed, which led to record levels of pension risk transfer (PRT).

However, “financial market volatility in late 2018 brought on largely by concerns of slowing global growth changed the game seemingly overnight,” Cerulli says. “Investment drawdowns in equities and fixed income overwhelmed higher contributions as well as any increase in long-term discount rates used to value pension liabilities.” In fact, the volatility was so pronounced that it wiped out all of 2018’s funding improvements.

Due to the Federal Reserve holding off on short-term interest rate increases in early 2019, the markets rebounded. However, Cerulli says, “despite the bounce back, one can’t fault a corporate DB CIO for feeling shell-shocked. Recalling the 2007-2008 global financial crisis losses, CIOs tell Cerulli that their companies cannot stomach such volatility again.” Sixty-three percent said funded status volatility and the uncertainty of pension contribution levels encouraged them to derisk.

Forty-two percent of these DB managers are concerned about interest rates, although 37% are relatively not concerned. Fifty-six percent rank strategic asset allocation advice and 44% rate tactical asset allocation as very important. Only 47% use an investment consultant.

These DB sponsors say that 53% of their assets are in liability-hedging strategies. Asked what they plan to look for in asset management searches in the next 12 months, the majority said better risk-adjusted returns. They said they plan to turn to private equity, real estate and hedge funds.

“Cerulli suggests asset managers help corporate DB plans take a more holistic view of investment performance and risk, particularly when it comes to asset-liability management,” the report says. Particularly, Cerulli suggests that asset managers:

• Help corporate DB plans finalize derisking goals and milestones and educate them about the difference between LDI and typical investment strategies.
• Run scenarios and holdings-based risk analysis for corporate DB plans in an asset-liability framework.
• Provide thought leadership on long-duration fixed income liquidity and the use of various types of derivatives in an LDI portfolio.
• Educate plans on the differences in performance reporting and analysis in an LDI context compared to traditional quarterly reporting.
• Explain the benefits of custom versus market index glidepaths.
• Offer a vision of the future and options if the ultimate goal is plan termination.