The typical pension fund started the quarter with a funding ratio of approximately 105% and ended the quarter at a funding ratio of approximately 115%, UBS said in a press release. The firm attributed the funding improvement to strength in both the domestic and international equity markets coupled with negative liability returns, due to rising interest rates.
However, Aaron Meder, UBS Global Asset Management’s Head of Asset Liability Investment Solutions in the Americas, said in the release that there was continued funding ratio volatility during the quarter due to both interest rate and equity market volatility. The value of liabilities in the month of April, as measured by the iBoxx US Pension Liability indices, rose approximately 50 basis points, then, from the end of April to the end of June, the discount rate applied to pension liabilities increased substantially, driving the value of liabilities downward by over 4% for the entire quarter, UBS said.
Domestic and international equity markets were also volatile, increasing by about 8% in total for April and May and dropping 2% in June, as measured by the S&P 500 Index and the MSCI EAFE Free Net Index, respectively.
Meder pointed out that liability-driven investment (LDI) strategies can protect against such volatility. “This is an opportune time to implement an LDI strategy focused on managing liability risk and generating efficient returns,” said Meder, in the release. “We believe that the funding ratio improvement seen during 2006 that has carried into the first and second quarters of 2007 presents an outstanding opportunity to hedge some liability risk. Ideally, this is combined with a shift to more of an absolute return generation focus.”
The US Pension Funds Fitness Tracker is the ratio of the asset index over the liability index. Assuming all other factors remain constant; it combines asset and liability returns and measures the impact of a “typical” investment strategy on the funding ratio of a model defined benefit plan in the US due to interest rollup, change in interest rates and typical asset performance.