A Capital Efficient Approach for Managing DB Plan Assets
- “Capital efficiency” is a term used to describe the effective deployment of assets in achieving desired risk and return characteristics.
- By increasing the duration of fixed income portfolios, DB plans can accomplish hedging objectives with less capital, freeing up assets that can be added to the growth portfolio.
- Reduced equity beta strategies, such as minimum volatility equities, can be used to manage a plan’s overall beta to stocks and further improve its risk / return profile.
Even as equity markets have largely recovered from first-quarter declines, lower discount rates have degraded the funding ratios of many defined benefit (DB) pension plans. Because bond yields are likely to persist at historically low levels as a result of long-term secular forces, in many cases DB plan sponsors won’t be able to count on yield increases to improve their funding ratios. This leaves plan sponsors with an urgent question: How can they close their funding gaps through investment gains (rather than contributions) in order to meet future obligations? Given the prospect that equities may go higher, and that low discount yields may endure or go even lower, plans looking to both close their funding gap and maintain prudent hedge ratios should consider a more capital efficient approach.