Implicit in this model is underfunded plans typically carrying higher equity exposure. Having a customized Liability-Driven Investing (LDI) program with a risk-managed equity component allows underfunded pension plans to comfortably carry higher equity allocations without amplifying funded status volatility.
Equity exposure — a sword that can cut both ways
While the prevalence of defined benefit plans has dwindled, the industry has seen a transformation in the approach taken to funding plans and managing liabilities. A large percentage of plans continue to face funding shortfalls. Because of the recent increases in pension insurance requirements, improving this funding shortfall is a key objective for many such plans. Ironically, it is often these plans that also may take the most risks with their underlying investments. In pension asset management, the lion’s share of this risk is introduced via the plan’s equity allocation, typically representing 35 to 45 percent of the portfolio.1 The impact of periods of equity market volatility on funded status is often under appreciated; equity losses are not offset by liability decreases, as is the case with fixed income investments. Thus, pension plan sponsors are very sensitive to the impact that equity market volatility can have on the funded status of their plans.
Equity risk management
Including risk-managed equity asset solutions as part of a customized dynamic LDI strategy can provide more consistent returns while helping to limit the impact of equity market volatility. Securian Asset Management, Inc. (Securian AM) can tailor an equity portfolio strategy to constrain equity downside exposure within a plan sponsor’s equity risk tolerance. Episodes of volatility tend to demonstrate persistence. High volatility periods tend to lead to unfavorable risk asset performance, while periods of low volatility could possibly produce better performance profiles for risky asset classes.