“Expanding the Fixed Income Opportunity Set for Public Pension Plans,” authored by Peter Austin, head of Fixed Income Solutions for T. Rowe Price, and Justin Harvey, strategist, Fixed Income Solutions, looks at 25 of the largest U.S. defined benefit pension plans. Results show the fixed income portfolios of these plans lean towards high grade, U.S.-centered assets.
Austin and Harvey find, “only a weak correlation between the amount invested in these core allocations and those of more volatile return-seeking assets.” They say this suggests such core allocations are a default option rather than a formal strategy to protect a portfolio against market volatility.
“We believe that many state and local pension plans could benefit by revising their fixed income investment policies to take advantage of a global opportunity set that now offers greater potential for higher returns and better diversification,” say Austin and Harvey.
The study acknowledges that relying on core allocations as the primary driver of fixed income returns can result in lower volatility, but points out that it may also result in lower returns. The authors of the study suggest that for those plans without investment policy restrictions, plan sponsors may want to consider a potentially higher risk and/or higher return profile for their fixed income allocations. They offer several hypothetical portfolio models including public plan base-case portfolio, fixed income sector allocations, and performance of hypothetical base portfolio and global multisector allocations.
Austin and Harvey believe sponsors of public pension plans are well positioned to utilize the full global fixed income opportunity set, which now offers far greater return and diversification potential than it did even a decade ago. They add that many plans could benefit from the inclusion of a wider range of non-core strategies in their portfolios, perhaps via a global multisector vehicle that permits tactical management of sectors, regions and risk factors.
By taking a more opportunistic, but diversified, approach to fixed income, the study authors conclude public pension plans may be able to improve returns and funded status without significantly altering their existing risk profiles. In a difficult economic and fiscal environment, this opportunity could prove attractive to many plans.
More information about the paper can be requested by emailing Bill_Benintende@troweprice.com.