Liability Driven Investing

Managing Risks with Strategic Pension Solutions

Accounting rule changes have altered the financial consequences for sponsors of defined benefit plans. “Mark to market” accounting can expose a plan to short term swings in funded status and require additional contributions or weaken a firm’s financial condition.

Today’s plan sponsors continue to seek to minimize long-term pension costs; however, they are becoming increasingly sensitive to short-term outcomes. Consequently, they need to balance the benefits gained by better aligning their assets and liabilities with the potential for reduced expected returns and a subsequent increase in long-term costs.

Liability Driven Investing

An asset allocation process that ignores a pension plan’s liabilities may lead to high volatility in funded status and contribution requirements. Sophisticated asset/liability modeling and innovative financial techniques, however, can help generate excess returns overliability growth rates while reducing the mismatch between assets and liabilities that cause unwanted volatility. Significant improvements are possible through the extension of portfolio duration to hedge the interest rate sensitivity of the liability. Further improvement is also possible through the reduction of market risk and the increase of active management risk.

The MASS Group offers extensive pension diagnostic capabilities and solutions that address the challenges and obligations facing plan sponsors today. Through the creation of a liability benchmark portfolio comprised of interest rate swaps or futures, we can closely match the interest rate sensitivity and other characteristics of the pension liability. By combining such a liability matching fixed income solution with a portable alpha strategy, we can produce the higher expected returns needed to reduce long-term costs while providing a higher correlation of assets to liabilities to reduce short-term volatility.