JPM: Current De-Risking Strategies Might Encourage DB Plan Terminations

J.P. Morgan says a strategy change from LDI is needed to facilitate pension stabilization.

The theory of asset allocation was perhaps first summed up in Mark Twain’s novel “Pudd’nhead Wilson”: “Put all your eggs in one basket and—watch that basket.” But diversification in too many pension portfolios nowadays is askew, and at a time when lots of corporate defined benefit plans are reaching fully funded status.

That’s the conclusion of a study from J.P. Morgan Asset Management, which criticizes the de-risking strategies that numerous company plans have stayed with after suffering major losses in the 2008-09 financial crisis—when they should have re-tooled their approaches. The emphasis since the crisis— liability-driven investment, or LDI—is basically to shift more into fixed income and out of riskier, more volatile equities.

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

JPM’s answer: Move away from mainly stocks and bonds and add more alternatives. That will bring better investment terms without taking on too much risk, the study suggests. Focusing “exclusively on risk reduction” is no longer necessary or desirable, says Jared Gross, head of JPM’s institutional portfolio strategy, and a co-author of the study.

The aggregate pension funded status of corporate plans was an estimated 96% as of the end of 2021, up from 88% in 2020, according to Willis Towers Watson. What’s more, Gross notes, plan regulatory strictures have been relaxed. So, for instance, a temporary decrease in funded status no longer requires a sponsor to raise its contribution, he observes.

The de-risking progression has reached a point of diminishing value, the JPM study contends. It “robs plans of the returns they need to remain fully funded and stable across time,” the report reads. In short, returns suffer. “That’s inefficient,” says Gross. A separate paper he co-authored says “an inability to generate excess returns will simply encourage sponsors to terminate their plans.”

J.P. Morgan’s study report advocates peppering in the likes of real estate, emerging market debt, private credit, and hedge funds into portfolios. “Liquid and illiquid assets should be balanced to ensure that access to capital is maintained but opportunities to generate uncorrelated returns are captured effectively,” the report says.

To Charles Van Vleet, Textron’s assistant treasurer and CIO, the new JPM framework makes sense, and he is a fan of alts. “Plans on an LDI path generally become less and less diversified,” he says. Plans are “commonly reduced to investment-grade corporate bonds and a splash of growth assets: 10% to 15% of public or private equity.”

Better, he went on, are such alts as long-duration collateralized mortgage obligations and levered first lien loans. The Textron plan is 111% funded, with a 7.25% expected return on assets.

Corporate plans have just 19% in alternatives, per a 2021 Milliman study. The rest was split between bonds (50%) and stocks (31%), with bonds up slightly from the previous few years, thanks to LDI.

This article originally appeared on the website of CIO, PLANSPONSOR’s sister publication.