De-Risking Effectively Using Fixed-Income Building Blocks
Despite the significant increase in volatility in 2022, corporate defined benefit (DB) plans' funding ratios improved further after rising in 2021. DB funding status reached 111.2% as of November 30, 2022, versus 97.6% as of November 30, 2021.1 This increase reflects the sharp rise in bond yields that has pushed liabilities lower. As a result, pension plans continue to seek to efficiently de-risk and increase allocation to fixed income. However, it is important that de-risking is performed thoughtfully to achieve each plan’s goals.
De-risking is an important strategic tool for plans practicing liability-driven investing (LDI). De-risking carried out through a shift from return-seeking assets (such as equities and real assets) toward liability-hedging assets (high-quality, long-duration fixed income) has been a dominant theme for corporate DB plans over the past decade. However, there are important pitfalls in using standard long-dated indexes to hedge the interest rate movements that could impact the plan’s expected liability stream. These pitfalls could prevent LDI investors from accomplishing their investment goals.