Capital-Market-Aware LDI: Actively Navigating the De-Risking Journey

Abstract

In corporate pension portfolios, de-risking from stocks to bonds is often driven by funded status, with the bond allocation increasing as funded status improves. A question naturally arises out of the practice of de-risking: If de-risking based on funded-status improvement is an effective way for plans to preserve gains, does re-risking a plan’s portfolio as funded status deteriorates prove to be an effective way to recover from losses? To answer this question, the authors compare funded-status-driven re-risking to an active re-risking strategy driven by market factors. They find that re-risking driven solely by funded status adds marginal value at the cost of potentially significant additional risk, whereas an active approach to re-risking may assist in both generating alpha versus the liability as well as mitigating downside risk.

TOPICS: Retirement, risk management