The typical corporate defined benefit plan ended the third quarter at around 70% funded, a modest decrease from the previous quarter, according to a report from Legal & General Investment Management America.
Despite global equities returning about 7% for the quarter, the discount rate fell 25 basis points to 4.15%, resulting in a 6% increase in pension liabilities. Equity markets have been up more than 15% year-to-date Sept. 30, but the funded status has actually fallen by one or two percentage points, said Gary Veerman, pension solutions strategist at LGIMA.
Equity markets are at five-year highs and “usually plans use those returns to boost the funded status, which hasn't happened,” Mr. Veerman said in a telephone interview. He added LGIMA has been talking with clients about equity protection strategies.
Mr. Veerman said the higher an allocation a plan has to equities, the lower the level of credit spread hedging it should have in a fixed-income portfolio because of the negative correlation. However, he said a growing trend has been to increase allocations to credit and decrease those to interest rates. Credit spreads tightened by 30 basis points in the last quarter. In a time of short-term uncertainty, he recommends keeping a minimum hedge ratio.
If pension funds want to take that approach, they should use “active LDI” to move in and out of credit and Treasuries, Mr. Veerman said.