PBGC says goodbye to LDI

Agency reallocates almost $15 billion to stocks, alternatives

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Charles E.F. Millard cited the PBGCs time horizon as reason for the change.

WASHINGTON The Pension Benefit Guaranty Corp. is abandoning its 4-year-old liability-driven investment policy, reallocating almost $15 billion to equities and alternative investments.

Asset-liability matching makes the most sense when youre fully funded or nearly fully funded, Charles E.F. Millard, PBGC director, said in an interview. We have a very long time horizon. If you need to send your kid to college next year, you should be in bonds. If youre making a payment to retirees in 20 years or so, then you should be more diversified.

The PBGCs move comes at a time when many corporate pension executives have adopted or are contemplating adopting LDI strategies. But they generally avoid LDI strategies if their plans are underfunded.

Mr. Millard said the agency will be hiring new money managers, with some being brought on board as early as this year.

He said PBGC officials probably will hire index managers first, where that makes sense, but will also be considering active managers. PBGC executives believe a more aggressive investment policy gives the agency a much better shot at eliminating its $14 billion deficit without raising the premiums charged to plan sponsors.

We have an obligation to take advantage of the tools the marketplace offers, as long as we do so prudently, to avoid a taxpayer bailout, Mr. Millard said.

The new investment policy, approved Feb. 12 by the agencys board, targets 45% of its $55 billion available for investment in equities, 45% in fixed income and 10% in alternative investments, including private equity and private real estate.

The old asset allocation, in place since January 2004, was 75% to 85% fixed income and 15% to 25% equities.

Even though the switch represents a radical change in policy for PBGC, its still conservative when compared to that of most pension funds and institutional investors.

This is an appropriate level of diversification and an appropriate level of risk, given the long-term nature of PBGCs liabilities, said Joe Nankof, a partner at consultant Rocaton Investment Advisors LLC, Norwalk, Conn., which did the asset-liability study upon which the asset mix changes were based.

We believe it (the new policy) is more diversified and will lead to less downside risk than a traditional 60/40 (equities/bonds) mix, Mr. Nankof added.

But there is concern in some quarters that if there is a downturn in the equity market, the PBGCs new policy will undermine its ability to act as an insurer because both the agency and the plans it insures will suffer losses in their equity portfolios at the same time.

Its poor risk management, said Mark Ruloff, director, asset allocation, at Watson Wyatt Worldwide, Arlington, Va.

According to Mr. Ruloffs analysis, the PBGCs new policy allocation increases its potential vulnerability. If the stock market suffers a severe downturn, he said, more pension plan sponsors could dump their underfunded plans on the PBGC at the exact same time they (PBGC) will be having problems of their own because they have equity investments as well, Mr. Ruloff said.

Studies by both Rocaton and the PBGC staff showed that sticking to the old investment policy gave the PBGC a 19% chance of achieving full funding for the agency in 10 years, while the new policy would give the agency a 57% chance of full funding in 10 years, without increasing premiums, Mr. Millard said.

Another PBGC study in its 2007 annual management report showed the bond-heavy investment policy could be accompanied by significant opportunity costs.

$7.3 billion more

That report said the PBGC would have had $7.3 billion more in assets for the five-year period ended Sept. 30 if its assets had been invested 60% in the Standard & Poors 500 index and 40% in the Lehman Brothers Aggregate bond index. Last year, Pensions & Investments estimated the PBGC had incurred a $4 billion opportunity loss over the three-year period ended Sept. 30 (P&I, Nov. 26).

Mr. Millard, who joined the PBGC last May, previously was a managing director for Broadway Partners, a real estate investment and management firm based in New York. He also formerly worked for Lehman Brothers and Prudential Securities.

The long-duration fixed-income managers handling PBGCs asset-liability matching are Pacific Investment Management Co., Prudential Investment Management Inc., Wellington Management Co. LLP and Western Asset Management Co., according to the PBGC.

The agencys 2007 annual management report showed it had $37.6 billion invested in fixed-income securities as of Sept. 30, and spokesman Jeffrey Speicher said the vast majority of the fixed-income securities are invested in the long-duration fixed-income strategy.

The PBGCs new investment policy statement has these allocations:

•Core equities: U.S. equities, 20%; non-U.S. developed markets, 19%.

•Emerging market equities, 6%.

•Core fixed income: long corporate bonds, 14%; long Treasury bonds, 22%; Treasury inflation-protected securities, 4%.

•Alternative fixed income: high yield, 2%; emerging market debt, 3%.

•Other alternatives: private real estate, 5%; private equity (buyout and venture), 5%.

In its investment policy statement, the PBGC said the external managers generally would be selected with the help of an investment consultant. PBGCs current consultant is Wilshire Associates Inc., Santa Monica, Calif.

Hedge fund managers need not apply, however. Under its new allocation for alternative investments, the PBGC is limiting its universe to private real estate and private equity.

We didnt think we would try to do everything at once, Mr. Millard said.