Dynamic investment policies gaining favor, says Aon Hewitt

U.S. corporate pension plans are shifting their assets into derisking liability-matching strategies to reduce volatility, particularly a “dark horse” strategy, mostly at the expense of domestic equity allocations, according to a new survey by Aon Hewitt.

Among derisking strategies, the “dark horse” strategy of dynamic investment policies has surpassed liability-driven investing, the previous favorite, noted a report, "Global Pension Risk Survey 2011."

By 2010, 21% of plan executives surveyed had already adopted some form of dynamic investment policy, up from 15% in 2009, the report said. In 2011, 29% of sponsors expect to use a form of dynamic investment policy.

“Overall, survey results show a greater awareness of pension risk, an understanding of the capabilities and limits of the available risk management tools,” according to a report on the survey results.

Among the findings:

• 38% of plan executives reduced their exposure to domestic equities, and the same percentage expect to do so in 2011;

• 4% expect to increase domestic equity exposure;

• 32% expect to increase allocation to long-duration bonds, 24% to increase other corporate bonds, and 13% to government bonds; and

• 4% expect to reduce their exposure to corporate bonds.

“Once just a strategic idea without much traction, liability-matching investments continue to grow as a proportion of plan assets,” Ari Jacobs, retirement strategy leader at Aon Hewitt, said in a statement about the survey.

“Regardless of the future direction of equity and bond markets, this shift should bring less volatility and greater predictability to pension plan costs.”

“Static investment policies are giving way to dynamic investment policies, or ‘glidepaths,' that incorporate plan-specific objectives, such as funded status, to mitigate pension risk,” the statement said. Glidepaths represent a way of planning a transition to increasing allocations to liability-matching strategies, such as LDI.

Dynamic investment policies have become an attractive strategy, the report said. Among the chief reasons for using dynamic investment strategies, the survey found:

• 78% of plan executives “view glidepaths as a sensible way to reduce risk as their plans' funded status improves”;

• 42% feel they are an appealing way to take the emotion out of derisking decisions; and

• 33% believe glidepaths offer the potential to reduce long-term plan costs.

“Most sponsors believe that their plans should take on less risk as they reach full-funded status,” Mr. Jacobs said in the statement, noting that “glidepaths can potentially reduce cost even as they reduce risk.”

Among other findings, 20% of plans raised their global equity allocation in 2010, while 13% lowered their exposure. “Roughly equal proportions expect to raise and lower this exposure in the next 12 months,” the report said. Also, 21% raised allocations to alternative asset classes, while 10% lowered exposure. Some 19% expect to raise allocations to alternatives this year, while 8% expect to lower exposure.

“Derisking wasn't just about extending bond duration in 2010 — diversification of the return-seeking portfolio was just as important,” the report said, noting the interest in expanding allocations to alternatives and global equities.

Plan funding has improved, according to survey results. Only 67% of plans expect to make additional pension contributions in the next 12 months, down from 83% in the previous survey. Of the 67%, 6% expect to issue debt to fund the contributions and 2% expect to use company stock for the contribution.

Among priorities in monitoring pension risk, 76% of plans monitor asset liability and funded status regularly; 21% monitor asset performance and liability/funded status performance on an ad-hoc basis; and 3% monitor asset performance only. Among plans' investment committees, 57% have a balanced focus on asset and funded status issues; 34% on assets and investment manager issues; and 9% on asset-liability or funded status issues.

Sixteen percent of funds “are very likely to implement” longevity-hedging strategies, while 10% have already done so, and 32% have already delegated full responsibility for implementation of their investment policy or are very or somewhat likely to do so in the future.

Delegation “suggests rising awareness” of a need for more resources “to implement risk-controlled strategies such as dynamic investment policies, as well as an urgent sense that missed opportunities can be costly,” the report said.

As sponsors reduce investment risk, “fewer are making fundamental changes to their plan design,” the report said. “Investment policy, rather than plan design, has become the primary risk management tool for plan sponsors,” the report said.

Some 63% of plans surveyed were closed to new entrants and 3% were likely to do so.

Of the reasons why sponsors are keeping their plans open, the survey found, 78% cited the defined benefit plan as aligned with the company's “total rewards” philosophy. Another 46% did so for competitive reasons, 39% because of union pressure, 38% because of employee pressure and 36% because of senior management resistance.

Aon Hewitt surveyed defined benefit plan executives of 227 large U.S. companies, representing $389 billion in total combined assets, in late 2010 and early this year. 