The COVID-19 pandemic and widespread lockdowns curtailing social and economic activity have led to a depression-magnitude slowdown. Equity markets plummeted and then rallied; volatility remains heightened. Interest rates reached historic lows. The speed and scale of the first-quarter dislocation across asset classes was unprecedented. This is a perfect storm for defined benefit (DB) pension plans.
In response to this major market disruption, many DB plans sought to rebalance their assets in order to adhere to strategic target weights, meet benefit payments, adjust hedge ratios, or express a market view. In our role as an outsourced solutions provider with dedicated investment management and portfolio implementation professionals, we reacted quickly to market volatility, rebalancing assets thoughtfully and cost efficiently in a challenging liquidity environment. In this article, we’ll explore the concerns and needs of one of our DB clients and the steps we took to fulfill those needs during the recent drawdown.
Our Client’s Key Concerns
As the pandemic began to hit the global economy in March, asset owners’ attention turned to rapidly changing portfolio fundamentals, in particular liquidity and risk exposures. The crisis intensified the need for detailed and frequent information for our client, a large DB plan. We had implemented a new interest-rate futures overlay for this client in the second half of 2019, in order to increase its hedge ratio and mitigate funded status volatility.
As the crisis set in, equity and fixed income markets (particularly long-duration Treasuries) decoupled, and the client’s portfolio exposures shifted dramatically within the new overlay portfolio, as well as in their public and private risk-asset allocations. Naturally, the client was focused on our ability to deliver against the risk and return objectives of the overlay program, while also overseeing and managing risk asset exposures; maintaining ample liquidity for plan disbursements and near-term obligations; and taking advantage of long-term opportunities as they emerged. In addition to maintaining extraordinary vigilance over the portfolio, our client was also obligated, of course, to deliver frequent, detailed updates to their own stakeholders.
We immediately recognized the need for heightened transparency into our management activities and more frequent communication to ensure efficient information sharing. Our first step was to establish a daily morning meeting with our client to discuss the prior day’s market activity and its impact on the plan, detail our management approach, and answer client questions. Key topics included providing updates on estimated funded status and hedging ratios, risk exposures, and implementation options. To address the client’s need for visibility into plan liquidity in the event of further stress, we provided data on transaction costs and market conditions across every asset class in the portfolio that might be called upon as a source of capital. Collateral within the interest-rate futures overlay was subjected to daily adequacy and stress testing. Hands-on, dedicated trading and implementation capabilities, and supporting risk analytics, were critical to managing operational risks while maintaining exposure. Combined with detailed short- and medium-term cash flow projections, the client could confidently discuss with their stakeholders how the plan might weather even more severe turmoil.
In the private markets portfolio, our alternatives team actively assessed the impact on direct and fund investments with a particular focus on liquidity and operational risks. Within the directly-managed real estate portfolio, this included real-time data gathering through individual tenant outreach, as well as constant evaluation of potential government facilities and support programs as those took shape. We leveraged the team’s experience to briskly adapt our thematic investment approach in light of the dramatic shifts in the market. This ultimately allowed us to take advantage of distressed market opportunities in real estate, private equity and debt markets, underwriting opportunities quickly and thoroughly in an effort to maximize access to the most timely and advantageous deals.
Within the public markets portfolio, our team has delegated discretion to position the portfolio around strategic targets, both to manage risk and enhance returns. Given the rapidly evolving market environment, the team was particularly careful to update views and positions in response to incoming information. To provide further visibility into the structure of our tactical intentions, we provided the client with a “blueprint” — a detailed but appropriately flexible description of our expected portfolio positions — across a range of scenarios. These scenarios included a range of potential macro and policy backdrops as well as asset-class fundamentals, valuations and relative value across asset classes. This level of transparency allowed our client to understand our management approach even as market conditions changed, which allowed them to provide reassurance and transparency to their own stakeholders.
Just as our private markets team was able to take advantage of market conditions to underwrite opportunistic deals, our public-side market positioning team was able to add alpha to the client’s portfolio through nimble positioning adjustments. This included quickly dialing down risk exposure as the scope of the crisis came into focus in March, as well as adding risk later that month, when depressed asset valuations had pushed the portfolio far from long-term targets. To make this happen, we employed both disciplined asset rebalancing approaches as well as the opportunistic use of options overlays, which were attractively priced ways to manage risk and generate income given heightened levels of implied volatility.
Through all market environments, we must always deliver against our promise to be a true extension of staff for our asset owner clients. In crisis periods, our standards of fiduciary management only rise. In this case, our client found themselves with a new portfolio structure and required a heightened level of interaction and customized reporting in order to fulfill their own oversight responsibilities and to communicate with internal stakeholders and senior management. As an outsourced fiduciary, we were uniquely equipped to deliver enhanced reporting in a streamlined and user-friendly manner, with advice and depth of supporting analysis.
We delivered positive financial results against targets across all major asset classes while seamlessly fulfilling all normal plan obligations, executing with no operational errors via our dedicated implementation team. Delivering these investment results is not simply a function of our breadth of capabilities; it is a result of our ability to coordinate across those capabilities and manage multiple layers of risk simultaneously, as a trusted fiduciary partner.
About State Street Global Advisors
For four decades, State Street Global Advisors has served the world’s governments, institutions and financial advisors. With a rigorous, risk-aware approach built on research, analysis and market-tested experience, we build from a breadth of active and index strategies to create costeffective solutions. As stewards, we help portfolio companies see that what is fair for people and sustainable for the planet can deliver long-term performance. And, as pioneers in index, ETF, and ESG investing, we are always inventing new ways to invest. As a result, we have become the world’s third-largest asset manager with US $2.69 trillion* under our care.
* AUM reflects approximately $50.01 billion USD (as of March 31, 2020), with respect to which State Street Global Advisors Funds Distributors, LLC (SSGA FD) serves as marketing agent; SSGA FD and State Street Global Advisors are affiliated.
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