A framework for setting and achieving pension objectives
Pension plans relying on their portfolios to attain surplus funding targets are likely to face an intensifying challenge, given an environment of depressed interest rates, inflated plan liability values and increased market volatility.
We believe the first step toward success in managing pension portfolios is to clearly identify the plan’s ultimate objective (e.g., managing the plan in perpetuity, or partial or full termination) and to translate that objective into a measurable goal—namely, reaching a specified funded status within a desired time frame and with an acceptable level of risk.
We lay out a required return and surplus volatility framework that can assist plan sponsors in shaping their asset allocations to help them achieve plan objectives.
The result is neither a one-size-fits-all nor an immutable solution but, rather, one that recognizes the unique characteristics of each pension plan and has the flexibility to adapt to evolving market and interest rate conditions, shifting actuarial assumptions and a changing regulatory environment.
The S&P 500 bottomed in March 2009, during the most severe U.S. economic recession since the Great Depression. The period following the global financial crisis has been challenging for pension plans despite 13.0% annualized global equity returns from March 2009 through April 2019.1 Falling interest rates and tightening credit spreads have driven discount rates lower and inflated plan liabilities. Rising liabilities, despite strong asset gains, have left the average corporate pension plan 87.2% funded as of December 31, 2018.2 Looking ahead, given increasing market volatility and depressed long-term interest rates, it will become more difficult for pension plans to rely on their portfolios to reach a surplus funding level. While each pension plan and its plan sponsor face unique challenges and constraints, we believe the first step in any investment program should be to define plan objectives and associated funding goals.
Defining objectives and determining “success”
Many pensions share similar features or characteristics; however, it is our experience that any adjoined plan and plan sponsor are unique in their combined goals and constraints. This precludes a one-size-fits-all approach to defining plan objectives and ultimately building pension portfolios. Each of the considerations in EXHIBIT 1 can significantly influence a plan’s risk tolerance and long-term objectives.
Each pension plan represents a unique combination of characteristics, goals and constraints
EXHIBIT 1: PENSION PLAN AND PLAN SPONSOR CHARACTERISTICS
Taken together, these criteria can help a plan sponsor define what “success” means and how much risk can be underwritten in the process of achieving its endgame. The goal of some plan sponsors is to manage the plan in perpetuity, while others may seek to strategically reduce the liability over time or, in some cases, fully terminate the plan. Still others may have a desire to grow surplus beyond what is needed to fund current plan participants. Whatever the endgame, clearly identifying sponsor objectives is an essential first step in defining plan success measures and shaping a strategy for reaching those goals across the pension life cycle.
1 J.P. Morgan Asset Management. Return data for MSCI ACWI Net from March 1, 2009–April 30, 2019.
2 J.P. Morgan Asset Management, Corporate Pension Peer Analysis 2018, GAAP funded status.