The market’s risk-on mentality has led to tighter credit spreads and decreased equity premiums. This has occurred alongside negative real yields in the US and other markets and central banks signaling a continuation of accommodative policies for the foreseeable future. These circumstances create major challenges for defined-benefit (DB) pension plans, causing many to question whether hedging liabilities still makes any sense. Spoiler alert: We think it does, but effective liability hedging in 2021 and beyond may require greater creativity and more expansive thinking, customized for the goals and the funding status of each individual plan.
We see five prominent headwinds for pension plans in 2021:
Challenge: Low yields and tight investment grade credit spreads
Challenge: High-flying equity valuations and elevated volatility
Challenge: Inflation exposure
Challenge: Funding uncertainty and increased plan expense
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