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BRAVING THE BEAR
July 20, 2022 | 9 Minute Read
The S&P 500 officially entered bear market territory in June 2022, posting the worst first-half performance since 1970. Amid heightened uncertainty but still-elevated funded levels, plan sponsors are taking a closer look at liability-hedging, hibernation, and de-risking strategies.
Corporate Pension Quarterly 2Q 2022: Braving the Bear highlights potential investment approaches and strategies to consider in the face of market volatility as plans approach their “end state” portfolios.
Historical Aggregate S&P 500 Funded Status1
Inflation expectations, central bank policy, and economic growth were key drivers of market volatility in the second quarter. With asset returns more negative than liability changes, our we estimate is that pension asset returns were -5.7% and -12.9% for the month and quarter, respectively.
Source: Goldman Sachs Asset Management as of June 30, 2022. Funded statuses reflect monthly estimates with the exception of year-end data.
Distribution of Funded Status
In light of heightened uncertainty, our estimate of the funded status for the aggregate S&P 500 plan fell from 98% on March 31st to 95% on June 30, 2022.
Source: Goldman Sachs Asset Management. As of June 30, 2022.
E = Estimated by Goldman Sachs Asset Management.
Portfolio Manager Perspectives: Evaluating the "End Point"
Jared Dickow
Multi Asset Solutions Group, Goldman Sachs Asset Management
Jared Dickow
How should plans evaluate whether their “end point” funded status is appropriate and what should the end state portfolio framework look like?
The end point on a glide path should align with a portfolio’s final objective. For hibernation, enough of a reserve is needed to minimize the likelihood of ever making another cash contribution. For termination, it is the level at which the plan is expected to be able to terminate with no additional contributions. An end state portfolio should seek to minimize funded status risk for a target return in excess of the liability (“surplus return”). The target surplus return should be built around the sponsor’s objectives and constraints, such as whether the sponsor intends to hibernate the plan or pursue a plan termination. Additionally, the sponsor’s willingness to utilize cash to bridge the gap to termination/hibernation, as well as their risk tolerance, play a key role in determining the target surplus return.
How should sponsors think about the role of private market securities in an end state portfolio?
Private market securities can often continue to play an important role in an end state portfolio because many pensions are in an ideal position to take on material illiquidity risk and benefit from the expected returns associated with that risk. While this is especially true for portfolios in a hibernation state, it can also be appropriate for sponsors who plan to eventually terminate their plan to use shorter duration or more liquid privates. Recently, we have seen increased interest from sponsors to include both investment grade and non-investment grade private credit as part of their liability-driven investing program. Other private assets, such as private equity and real assets, can also help to enhance returns and reduce risk when incorporated into a portfolio otherwise dominated by public market securities.
Building on that, if a sponsor may ultimately want to engage in a large scale risk transfer or a complete termination of their plan, how much should that influence what its end state portfolio may look like?
A sponsor that wishes to ultimately terminate its plan may consider reducing or ending new commitments to private market securities with a long tail. Either liquidating those positions or delivering them “in kind” to an insurer to pay for a group annuity contract to cover participants may result in a markdown that may be unattractive for the sponsor. Nonetheless, for sponsors that may only aspire to do a partial risk transfer as opposed to complete termination, an allocation to private markets may still be appropriate for the remaining portfolio. Additionally, shorter duration assets such as credit or secondary funds may continue to provide attractive opportunities with a more appropriate time horizon.
For years we talked about bifurcating portfolios between immunizing and return-generating. As we get closer to end state, this line seems more blurred. Should plans simply think about the portfolio holistically?
Yes, a holistic view may be the appropriate way to approach an end state portfolio, especially for sponsors envisioning a hibernation strategy. A focus on the level of surplus return generated by the total portfolio, which is often dominated by liability-hedging investment-grade fixed income securities at or near the end state, can become particularly important as plans will likely still require some level of return to cover the costs to maintain the plan (e.g. administrative expenses, PBGC premiums, actuarial losses). When considering the immunizing and return-generating assets separately, it is possible for a plan sponsor to lose sight of the ultimate goals of an end-state portfolio: minimizing surplus risk while generating sufficient surplus return to maintain the plan.
Strategy in Focus: Custom Liability-Driven Investing
To ensure their portfolio’s fixed income allocation is helping to minimize surplus risk, many plans have adopted custom liability driven investing (LDI) programs, whereby the assets are managed in relation to the plan’s underlying liabilities. Oftentimes these programs include the use of derivatives, such as interest rate swaps and futures. According to CIO Magazine’s 2021 LDI Survey, 61% of plans currently use derivatives as part of their LDI programs.
Greater Percentage of Portfolio in LDI
Source: CIO Magazine Liability-Driven Investment Survey. As of November 2021.
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Corporate Pension Quarterly 2Q 2022: Braving The Bear
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