At least four of the 10 biggest U.S. corporate pension plans have launched liability-driven investment programs, and a growing number of firms of all sizes are likely to do so in 2008 despite an unhelpful decline in interest rates.
Automakers General Motors Corp. and Ford Motor Co., aircraft giant Boeing Co. and the U.S. pension plan for telecom company Alcatel-Lucent all have begun marshaling long-duration bonds, interest-rate swaps and a growing array of absolute-return strategies to better match their assets to their liabilities. The four combined have defined benefit assets of more than $300 billion.
Observers say those ranks are poised to swell in 2008, as pension executives who have spent the past year or two getting comfortable with LDI-related issues increasingly move to the implementation stage.
Tracking that trend is complicated by the lack of a clear-cut definition of LDI, which can mean anything from immunizing 100% of a pension fund from interest-rate volatility to hedging a portion of the fund while seeking to enhance returns with the remaining assets, experts say.
To some extent, corporate pension funds have always taken liabilities into account when managing their investments, noted Judy Schub, the managing director of Bethesda, Md.-based Committee on Investment of Employee Benefit Assets. Of CIEBAs 110 corporate plan sponsor members, 75 of them have some LDI strategy, she said.
Mark A. Schmid, vice president of trust investments with Chicago-based Boeing and chief investment officer of the firms $46.2 billion defined benefit plan, agreed, saying the difference today is the relative degree to which we are doing LDI partly in response to the perfect storm of 2000 to 2002, when interest rates and stocks alike plunged.
Mr. Schmid said a typical big corporate plan might be adding another 10 to 20 percentage points to long-duration bond exposure. Over the past 18 months, Boeing lifted its long-bond exposure to 45% from 31% of its total assets, shifting those funds out of equities.
Corporate pension executives today are going well beyond back-of-the-envelope analyses getting their actuaries and consultants involved, seriously crunching numbers, said Nathan Dudley, assistant director of overlay services and head of LDI strategy with Tacoma, Wash.-based Russell Investments.
That homework is about to be translated into action, he predicted. While a year ago the conversation was, Do we put on an LDI program or not, today most pension executives have concluded its in their interest to hedge some of their exposure to interest-rate movements and it has simply become a question of timing, Mr. Dudley said.
The level of interest rates has been the key timing issue, with pension executives less enthusiastic about immunizing all or part of their pension funds when low rates are buoying the present value of future pension obligations. If rates go up after pension executives put on interest-rate hedges, those hedges lose money, noted Mr. Nathan.
Its easy to make the long-term strategic call to hedge, but a little more difficult to decide when to pull the trigger, agreed Boeings Mr. Schmid.
Recent credit-market volatility and uncertainties about how to value certain fixed-income instruments is further muddying the outlook, said Cynthia Steer, a managing director and chief research strategist with RogersCasey Inc., a Darien, Conn.-based investment consultant. The LDI trend remains in place, but the uncertain market environment could well slow the pace at which pension executives move forward with implementing a program, she said.
Some market participants predict any slowdown will be minimal. There may be a modest tapping of the brakes, but all the building blocks for implementing LDI programs have been put in place, and the momentum to push forward albeit with an incremental phase-in should prove unstoppable, said Kurt Winkelmann, managing director and head of global investment strategy with New York-based Goldman Sachs Asset Management.
He said he knows of no pension executive shelving plans to implement LDI.
Pension executives who are already a year or two into implementing LDI programs say the recent spike in market volatility and the fall in rates havent affected their plans.
Robert Hunkeler, vice president, investments with Stamford, Conn.-based International Paper, said his firms LDI strategy is doing what we thought it would do in terms of reducing the volatility of its $11.4 billion pension plans funding gap, with an added benefit: The hedge is actually making money for us, he said.
When International Paper began a three-year program to phase in a hedge of 50% of its pension liabilities, Mr. Hunkeler said the expectation was that rates would be rising. Instead, for each of the past two years, rates rose during the first half, only to decline later in the year, he said.
Two years into that three-year cycle, International Paper has achieved two-thirds of its hedging target. Despite the recent decline in rates, if the pension plan were just starting out today, it would proceed exactly the same way, Mr. Hunkeler said.
Charles Van Vleet, director of investments with United Technologies in Hartford, Conn., said his firms analysis is that 60% is the optimal amount of UTCs $17.5 billion in defined benefit assets to immunize from interest-rate volatility. After two years, the plan is halfway to that target, he said.
While boosting allocations to long-duration bonds is one means of getting there, using a variety of instruments including absolute-return products and interest-rate swaps to manage the mismatch in volatility between assets and liabilities offers a better chance of enjoying continued healthy returns on assets, he said. Like Mr. Hunkeler, Mr. Van Vleet said UTC officials would follow the same program if they were just starting out now.
Mr. Schmid, noting theres no cookie-cutter approach to LDI, said Boeing opted to give the 14 long-duration bond managers who oversee its fixed-income allocation authority to use interest-rate derivatives, rather than hiring a separate overlay manager.