Despite one of the worst stretches yet for equity and bond markets, on a calendar year-to-date basis, US Corporate pension plans have weathered the storm and realized funded status improvements of varying degrees (Figure 1). Rising interest rates, a flatter yield curve, and wider corporate bond spreads across the credit quality spectrum have driven liability discount rates higher and projected benefit obligations lower. On the pension asset side, equity assets outperformed liabilities on a relative basis even in the face of significant headwinds to broad based equities. 1
Less well funded pensions, which typically carry lower fixed income allocations and hence a lower interest rate hedge ratio, have seen more meaningful improvements YTD due to rising discount rates that pushed expected liabilities lower.
While the proxy growth asset returns assumed here (MSCI ACWI Index) do not account for the full breadth of investments, on a comparable basis, investors with greater allocations to defensive growth assets (low beta, quality- or value-oriented equities, multi sector credit, private investments), diversified real assets with higher betas to inflation, and private markets have seen incremental funded status improvements.
Activity and discussion across the pension space
Even well-funded plans further down the path to de-risking (higher fixed income allocations and higher hedge ratios) have seen improvements YTD, and on the heels of funded status gains in 2021, hibernation activity has continued to pick up. In addition, liability management activity and planned endgame actions in the form of lump sums and annuitizations/terminations (buy-ins and buy-outs) have also increased.
Less well-funded plans that have lower hedge ratios and have realized further funded status improvements have shifted their attention to increasing asset-liability hedge ratios.
In terms of the magnitude of the funding improvements, the last 16 months harken back to progress realized in 2013.
However, unlike 2013—when discount rates and equity markets (growth assets) were rising—today’s de-risking conversations are centered on potential hedge ratio increases generated by capital efficient fixed income strategies, including the use of an interest rate bond futures overlay.
Under this approach, sponsors can avoid a one-for-one de-risking by selling equities and buying long duration fixed income, at a less opportune time given the equity sell off. Instead, sponsors can increase hedge ratio by using a futures overlay, thereby retaining capital allocated to growth assets—while staying mindful of collateral requirements.
For younger, open and active plans and potentially cash balance plans with a higher hurdle rate of return requirement, we continue to see benefits in diversifying growth-oriented assets with private market assets and broad-based real assets that provide resiliency amid the new rate environment and persistent inflation.
Figure 1: Estimated Funded Status Improvements, Year-to-Date
5/31/2022: Estimated Funded Status based on Equities/FI Mix (%)
as of 12/31/2021
Based on representative DB portfolios using different asset allocations.
Source: Bloomberg Barclays, SSGA
Liability returns proxied by Bloomberg Long AA Credit Index, Asset returns based on MSCI ACWI Index and Bloomberg Long Govt/Credit Index
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