Institutional preparation for all seasons
For pension plans, the value of LTD
Many pension funds are focusing more on refining their liability-driven investments, especially in light of the strong performance of equities, which has improved the funding of many plans, McDonagh noted. âThe benefits of LDI can often be overlooked in an environment where risky assets offer significant returns. However, plan sponsors have the option of maintaining funded status through an LTD strategy once their plans are well funded.
How plan sponsors approach LDI depends on where they are in the path, he added. So you need to ask yourself, “How do you rate overall return versus minimizing volatility, and how do you deal with those competing goals?” By focusing on the concept and applying the principles, an LDI strategy can minimize volatility and provide appropriate levels of return. “
Those plans that have not implemented an adequate LDI strategy are trying to understand if they are facing a mismatch between their assets and liabilities and how that might change in different economic environments, McDonagh said. “Is the capitalization ratio stable or is it at risk of deteriorating?” And how much will the company have to fund the plan? Ultimately, LDI is about how best to ensure that the changing values ââof the pension fund’s investments and liabilities evolve in correlation.
LTD is an integral part of the transition path for plan sponsors considering retirement risk transfer, as well as plan hibernation or freeze. âMany plans have considered retirement risk transfer solutions in recent years. For those who have not actively pursued a transaction, that interest has come to the fore, âMcDonagh said.
Diversification of investments that balances stability and yield
On the defined contribution side, as plan sponsors contemplate a changing economic environment, they seek to offer plan members a balance between growth and capital preservation options, McDonagh said. âEquity solutions work well when paired with a stable value, and together they can provide a level of stability with a level of growth. When you look at market cycles, this type of diversification works effectively. We believe that all defined contribution plans should offer solutions that balance these risks. “
Stable-value solutions are attracting increased interest, especially among near-retirees and retirees, because they help reduce volatility and can provide stable income, McDonagh said. Stable value has long been a staple of DC plans, he noted, as a fixed income vehicle that offers a guaranteed envelope that smooths the lending rate – the effective annual return – over time. As credit rates come under pressure in a low interest rate environment, “offering a stable value option is an important decision for a fiduciary,” he said.
In contrast to the growth spectrum of returns, DC plan sponsors have favored target date funds and passively managed funds – both are solutions widely used by plan members. In addition to these basic strategies, many plan sponsors offer active, alpha-driven solutions in asset classes such as small cap stocks and fixed income. âYou need some of these solutions in your portfolio to try to beat inflation, and allocating appropriate to a participant’s risk tolerance helps provide diversified returns,â McDonagh said.
This same diversification of investment solutions, with the right mix of yield and volatility management solutions, meets the needs of institutions for their own portfolios, he added.
Protection offers to meet institutional needs
Institutions are showing increased interest in bank-owned life insurance and corporate-owned life insurance. BOLI / COLI policies provide life insurance coverage to a portion of an institution’s employees, with their consent, to help fund benefit solutions, McDonagh explained. “These solutions offer either an attractive credit rate from a well-rated financial institution, or access to various investment solutions, to effectively fund benefit offerings and help retain key employees.”
Even if you can’t predict, you can prepare
Ultimately, all institutions need to actively review their financial and risk management strategies and solutions to be optimally positioned in various market environments. âWhile long-term planning may be difficult right now, the periods of disruption and uncertainty we have seen over the past 18 months are a reminder that a long-term view leads to more thoughtful decision-making. on the assets in the portfolio offers an attractive risk-adjusted return, offsets market lows when they occur and also captures some of the highs, âMcDonagh said. The experience of navigating business cycles helps institutions achieve long-term, sustainable success.