Whether defined benefit (DB) plan sponsors are ready or not, the pension plan landscape is quickly changing, and to adjust, they need to take steps to shore up their investments, Willis Towers Watson says in a new report, “10 Investment Actions for Defined Benefit Plans in 2020.”
First, Willis Towers Watson says, the funding relief that sponsors have enjoyed is nearing an end. Many will need to increase their contributions to their DB plans, and to do so, they will need to revisit their budgets. “Know what you might owe, budget and identify potential sources for cash to help avoid surprises,” Willis Towers Watson says.
Second, due to numerous rate cuts by the Federal Reserve, interest rates are nearly at all-time lows. DB sponsors can respond by putting hedging strategies into place. “Each situation requires coordinated short- and long-term planning around investments, funding and liabilities,” Willis Towers Watson says.
Third, frozen DB plans may be nearing the end of their de-risking journey, and these plans need to come up with a solid exit strategy. “It’s time to decide whether your objective is termination, hibernation or somewhere in between,” Willis Towers Watson says. “In each case, you will likely need to look to enhance cash-flow matching and credit spread exposure. For termination-ready sponsors, you should prepare for upcoming liquidity needs, monitor transaction costs of potential trades and consider asset-in-kind transfer opportunities to streamline the final transfer to an insurance company.”
Fourth, many DB plans are embracing environmental, social and governance (ESG) investing. Willis Towers Watson says this is admirable, but DB sponsors still need to base their decisions on finances and their long-term goals.
Fifth, DB sponsors might want to consider outsourced chief investment officer (OCIO) resources. “Be realistic about the time, resources, money and expertise you can devote to investment actions and evaluate whether owning the big picture but outsourcing the details is right for you,” Willis Towers Watson suggests.
The consultancy’s next five points center around diversifying the DB portfolio. It believes that returns will be lower in the coming years, while volatility will spike. It says that equity and investment-grade bond valuations are inflated; there is the risk of recessions occurring, particularly in Europe and Japan; and that central banks are running low on policy tools to offset shocks.
The sixth thing Willis Towers Watson suggests that DB sponsors do is to add non-corporate credit to their portfolios. “Even though aggregate bonds, long credit bonds, high-yield bonds and bank loans may seem fairly different, they’re all tied to U.S. corporate borrowers and can be more correlated with equity returns than one might hope,” Willis Towers Watson says. “To better diversify your credit investments, we suggest considering other types of borrowers, such as consumers (e.g., securitized debt like credit cards, mortgages and student loans) and sovereigns (e.g., non U.S. government and corporate debt).”
The seventh move the consultancy suggests is to consider investing in real assets such as real estate and infrastructure, or more niche investments if “your tolerance for complexity allows for it.”
The eight suggestion is to take a different approach to current investments by employing strategies “such as merger arbitrage, volatility and momentum.”
Ninth is to study how much liquidity there should be in the portfolio and make sure that a plan isn’t overestimating how much it will need.
Finally, take a hard look at active investments and work with managers to include only their very best ideas, Willis Towers Watson says.
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