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Investment PerspectivesOctober 24, 2018

Meeting pension obligations while managing equity volatility

Pension plans can benefit from asset allocation models that include a dynamic equity allocation that decreases as the funded status increases.

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.

Historical average monthly returns by volatility bucket for major indices

  Average monthly return
1 month volatility Dow Jones S&P 500® Russell 2000 MSCI ACWI
2%–6% 1.95% 1.86% 2.76% 2.00%
6%–10% 1.51% 1.38% 1.95% 1.33%
10%–14% 0.99% 1.06% 1.43% 0.50%
14%–18% 0.88% 0.66% 1.75% 0.00%
18%–22% -0.10% 0.36% 0.19% -0.48%
>22% -3.06% 2.00% -2.72% -3.70%
Count 1,428 1,092 480 372
Period 1/1900–12/2018 1/1928–12/2018 1/1979–12/2018 1/1987–12/2018

Source: Bloomberg. As of 12/31/2018 data updated annually. The table shows the average monthly returns for the following major indexes: Dow Jones Industrial Average, S&P 500.; Russell 2000; MSCI ACWI, for the time periods shown where the average monthly volatility was in the different volatility categories shown. Volatility is measured as the annualized standard deviation of daily returns of the indices. The indices are unmanaged and investments cannot be made directly in the indices. See additional disclosures at the end of the materials for additional information

Custom equity risk management overlays can reduce the severity of downside risk and volatility

As part of an overall LDI strategy, we believe managing equity volatility can be a valuable defensive measure for a pension asset portfolio. For example, if a pool of pension assets includes a 40 percent equity allocation, a 50 percent loss, similar to the S&P 500® decline from October 2007 to March 2009, would decrease the plan funding status by 20 percent. By utilizing a risk overlay strategy that caps the equity loss at 25 percent, the worst-case scenario for the plan would be a reduction in funding status of 10 percent even with the broader market declining 50 percent. A very mild version of this was just experienced when the estimated aggregate funding status sponsored by S&P 1500 companies decreased by 1 percent in March 2018 to 87 percent at the end of the month, as a result of losses in the equity markets, according to a Mercer study.2 Adding a degree of stability by using risk-managed equity can be critical to help plans maintain funding status through challenging periods in the market, while still being able to capitalize on equity upside  potential.

Equity volatility directly translates into funded status volatility through asset valuation. Our team creates customized institutional investment solutions that exceed liability return requirements while managing funded status within clients’ risk appetites.

Craig Stapleton, CFA, FRM

Senior Vice President and Portfolio Manager

Your success is at the heart of all we do

When pension plans reach and maintain a fully funded status, everyone benefits. Securian AM delivers investment options that help plans keep pension promises.

  • Tailored solutions — our flexible suite of institutional investments allows us to adapt our strategies with changing pension plan needs and market conditions to create long-term solutions.
  • Collaborative approach — understanding your unique goals and helping you find the right path forward means being accessible, thoughtful and collaborative.
  • Experienced team — in today’s fast-changing and increasingly complex market, our experienced professionals can make a significant difference in achieving key plan objectives.

We Invest Together.

We follow the same guiding principals to create institutional investment solutions as we do to fulfill our own financial obligations. With a focus on long-term strategies that help organizations shrewdly manage risk, we offer organizations of all sizes access to sophisticated investment vehicles. Our suite of investment strategies include: public and private fixed income, commercial real estate debt and equity, pension solutions, and alternative investments.

Learn more about our Liability-Investing Strategy

1. Willis Towers Watson. “2015 Asset allocations in Fortune 1000 pension plans,” December 28, 2016.

2. Mercer Newsroom. “S&P 1500 pension funded status decreased by one percent in March,” April 5, 2018.

The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, Securian Asset Management, Inc. (Securian AM) does not guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this presentation are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Any forward-looking statements speak only as of the date they are made, and Securian AM assumes no duty to and does not undertake to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated.

Securian AM claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this article in compliance with the GIPS® standards. Securian AM has been independently verified for each of the ten years ended 12/31/2017. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS® standards on a firm‐wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS® standards. Verification does not ensure the accuracy of any specific composite presentation.

The S&P 500 Index consists of 500 large cap common stocks which together represent approximately 80% of the total U.S. stock market. It is a float-adjusted market-weighted index (stock price times float-adjusted shares outstanding), with each stock affecting the index in proportion to its market value.

Source: Securian Asset Management. Managed Volatility Equity represents the Securian AM Managed Volatility Equity composite. MSCI ACWI represents the MSCI All Country World Index. The Securian AM Managed Volatility Equity Custom Benchmark consists of 60% S&P 500 Low Volatility Index, 20% S&P BMI International Developed Low Volatility Index, and 20% Bloomberg Barclays U.S. 3 month Treasury Bellwethers. This information is supplemental to the GIPS - compliant presentation included as part of this presentation. Prior to January 1, 2019, the Composite tracked the Managed Volatility Equity Composite. The new benchmark is more representative of the industry standard for a comparable strategy. See additional disclosures at the end of the materials for additional information about Managed Volatility Equity Composite.

Securian Asset Management, Inc. is a subsidiary of Securian Financial Group, Inc.

For Institutional Investment Use Only

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