Many DB Plan Sponsors Adjusting LDI Strategies

Defined benefit plan sponsors have positive views of the direction interest rates will take and of equity markets, but they remain wary of how a continued pandemic will impact their plans.

More than two-thirds of defined benefit (DB) plan sponsors surveyed by NEPC use liability-driven investing (LDI) strategies.

NEPC’s “Defined Benefit Trends Survey” of 76 DB plans, which have more than $115 billion in pension assets in aggregate and represent a diverse cross-section of plan types, including corporate and health care, found 71% completed a formal review of their LDI glide paths during the past 12 months. For 45% of those plan sponsors, this resulted in them redefining their glide paths and modifying future trigger points.

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But Brad Smith, a partner at NEPC and a member of the firm’s corporate defined benefit team, says the most interesting finding to him is that 14% of those who reviewed their LDI glide paths re-risked their portfolios. “This is the largest percentage that we’ve seen re-risking their portfolios,” he says. Smith notes that the most recent pension relief legislation passed by Congress increased the amortization period plan sponsors can use for underfunding, and, as a result, NEPC started seeing clients evaluate their LDI glide path and re-risk their portfolios.

The survey found 68% of DB plan sponsors use funded status as a glide path trigger, while 22% use interest rates. While 48% hit a trigger on their LDI glide path and took action to de-risk their plans, 13% hit a trigger but delayed or deferred the de-risking action. Half of those who delayed the de-risking event said it was because of their view of the interest rate environment.

“Fifty-six percent of survey respondents said they expect discount rates to be higher 12 months from now, so they expect their plan’s funded status to improve,” Smith explains. “This gives plan sponsors more confidence in letting equity assets continue to run. Interestingly, the majority said there’s a low probability of a market correction in next 12 months, and 56% indicated they are bullish on the stock market.”

Three in 10 survey respondents said the ongoing pandemic and the future of COVID-19 is the greatest threat to their investment programs in the near term. Despite the majority saying there is a low probability of a market correction, Smith explains that most plan sponsors are looking back to the first quarter of last year when the equity markets sold off.

“As investment committees are looking at all risk items, that is in the forefront of their concerns,” he says. “Seeing lockdowns in other countries over the past few months, an increase in cases due to the Delta variant and vaccine efficacy waning, there is a general concern that if the pandemic continues or gets worse, it will pose a risk to the equity market. In addition, if it gets worse, there could be a slowdown in economic growth, and the worsening could cause political tensions—other issues plan sponsors cited as potential threats to their investment programs.”

For 2022, NEPC will continue to watch the path of inflation. “What’s interesting is that inflation is good for pension funded status, but an offset to that is if interest rates go up too much, it will impact the value of equities,” Smith says. “There could be a ‘Goldilocks’ area of higher discount rates, but not so high as to adversely impact equities. In that case, we could see a nice improvement in funded status next year. We’re cautiously optimistic. We think equities still have room to grow, and we don’t believe there’s a strong case for rampant inflation.”

The full 2021 survey results will be unveiled during an NEPC webinar in January.