Liability-driven investing (LDI) strategies have been used by defined benefit (DB) plans for decades, but gained steam with the passage of the Pension Protection Act (PPA) of 2006, which increased penalties for underfunded pensions, and the financial crisis of 2008, which reduced returns on assets dramatically.
With increased volatility of the markets and low interest rates increasing liabilities and the price of purchasing bonds, the question is, is LDI still effective? Yes, say experts, who believe LDI is still a viable approach for derisking DB plans.
According to October Three Consulting’s October Pension Finance Update, October was a down month for investors, but pension sponsors were able to tread water, as the impact of higher interest rates on pension liabilities offset asset losses. Both model pension plans it tracks saw basically flat results on the month. Through October, Plan A is down nearly 5% and the more conservative Plan B is down nearly 1% on the year.
Stocks lost ground in October: A diversified stock portfolio lost more than 2% during October but remains up more than 4% on the year. Interest rates saw their biggest jump in the year in October, producing losses of 1% to 2% on bond portfolios in October. For the year, bonds remain up 7% to 8%, with longer-duration bonds enjoying the best results.
Interest rates jumped more than 0.2% during October, reducing pension liabilities by 1% to 2%. Rates have moved higher since hitting all-time lows in July, but pension liabilities remain 8% to 12% higher than at the end of 2015, with long-duration plans seeing the biggest increases. NEXT: Considering the duration of bonds