Greek mythology tells the tale of Sisyphus, punished for deceit by having to push a boulder to the top of a hill, only to have it roll back down once it reaches the summit so he has to start again.
Many defined benefit (DB) plan sponsors today likely have a greater appreciation of Sisyphus’s never-ending task: After a decade of effort to improve the funded status of their plans following the Great Recession, many have seen their plan funded status fall dramatically due to market fallout from the COVID-19 pandemic.
It’s enough to make a sponsor want to end it all and just buy an annuity to close out the plan, a step many have taken during the past several years. However, the recent sharp decline in plan funding levels now makes a buyout much more expensive for the sponsor. Coupled with the U.S. Federal Reserve’s actions that will likely lower interest rates further, annuities are also expected to offer lower interest rates, only adding to a buyout’s cost.
Times like these may help plan sponsors better appreciate the impact of market volatility. It is also a reminder that there is little in the way of free lunches when it comes to investment risk and return.
The next steps sponsors must take will be during a period of abundant uncertainty. Volatility in equities may be with us for a while, and equity valuations are still down significantly, with little clarity as to when—or if—they will recover to levels reached in mid-February. The high demand for fixed income solutions is adding to the pressure on yields, with some (on a global basis) even going into negative territory. Governments have made major liquidity infusions to help respond to the demand crunch, but the results are not yet clear, and post-pandemic consumers may be slow to resume their previous spending habits.
Regardless of the conditions, DB plan sponsors need a strategy to help reach their goals. DB plans are long-term investment propositions and there will always be obstacles and challenges to overcome along the way. For plan sponsors, we encourage creating a liability-driven investing (LDI) journey plan, i.e., one that sufficiently diversifies their plans’ growth portfolio investment-risk-premia exposures and pays attention to the interest rate risks embedded in their liabilities. Plan sponsors that already have one in place may be able to better capture opportunities in the current environment. For those that don’t, however, it’s never too late to start.
Those without a journey plan—that are neither developing one nor planning a revamped investment process—are probably hoping for things to quickly recover so that they can continue as they previously have. That may offer them some relief in the short to medium term, but they remain vulnerable to another market dislocation at some point. And, as we have just experienced, dislocations can arrive fast and unexpectedly.
For sponsors without a long-term strategy, another risk, even for seasoned investors, is that it’s all too easy to get caught up in the moment and allow behavioral or other biases to lead to sub-optimal decision-making. It is an even greater risk for pension plans, where critical plan attributes are dependent on a number of hard-to-predict variables.
In the near term, and for those with the temerity to follow through, this could be a major short-term tactical buying opportunity. Those with a good strategic foundation and the necessary risk management tools already in place (including a journey plan) will be best positioned to take advantage of this potential opportunity, whether in equities or fixed income.
In the longer term, things are less clear. For plans in deficit with sponsors unwilling to make the contributions necessary to address their plan funding deficits, investment returns are the only tool available to close the gap. Such sponsors may be forced to retain higher growth portfolio allocations (i.e., equity investments) in order to pay all pension obligations as they fall due.
Hopefully, a solid majority, however, will improve their risk management approach to be able to fully see the risks they are taking by investing in equities and scale their allocation so it is consistent with their fiduciary risk appetite. The most robust way of doing this is by constructing an investment journey plan that is outcome-orientated and ultimately leads to attaining a given sponsor’s objectives for its plan, in the context of its overall core business.
Sean Kurian, FSA, CAIA, FIA, FRM, is managing director and head of Institutional Solutions at Conning.
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