But corporate defined benefit plans seem to have made the most progress, prompted by the regulatory imperatives set in stone by the Pension Protection Act of 2006.
Whether it's the growing number of sponsors shutting down their defined benefit plans, the broad-based shift in allocations from equities to fixed income or the adoption of tail-risk strategies, big corporations have taken significant steps over the past two or three years to reduce the risks to which pension plans expose their sponsoring organization, noted Gregory T. Williamson, chief investment officer and director of trust investments, the Americas, for Warrenville, Ill.-based BP PLC's $13.4 billion in U.S. retirement assets.
Corporate plans “were already marching toward liability-driven investing to begin with,” and the recent crisis has either convinced those already on that road to move faster or served as “the last straw” for others who were holding out, noted Eileen Neill, a managing director with Santa Monica, Calif.-based Wilshire Associates.
An equity market plunge of 20% or more would still be painful, but with well over 50% of the corporate plans BNY Mellon Asset Management talks to adopting some form of LDI, the fallout should be less drastic today than it would have been four years ago, said Peter Austin, Pittsburgh-based executive director of the BNY Mellon Pension Services unit.
Kevin Turner, managing director, consulting, with Seattle-based Russell Investments, agrees. He noted that roughly three-quarters of Russell's corporate clients have adopted some form of liability hedging, up sharply from three years ago. They're also moving to incrementally take risk off the table as funding levels recover.
Gretchen Tai, CIO of Palo Alto, Calif.-based Hewlett-Packard Co.'s $36 billion in retirement assets, said her team has continued to enhance its LDI approach, most recently adopting a system in late 2010 which dynamically adds or reduces risk exposure in response to the market's volatility and changes to funded status.
For HP, this amounts to a second bite of the LDI apple. The company completely immunized its frozen defined benefit plan in 2007, when it had achieved a funding level of more than 106%. But HP's 2008 acquisition of Electronic Data Systems Corp., which had a significantly underfunded DB plan, left the combined plan exposed to risky assets.
HP's combined $11 billion DB plan is now 90% funded, with the new dynamic asset allocation strategy's derivatives-based overlay program adjusting equity allocations and interest rate hedge ratios in a systematic way to add or reduce risk as markets fluctuate — unlike most “dynamic derisking” regimes which are only positioned to reduce risk as funding levels recover, Ms. Tai said.
Looking at the broad investment landscape, some observers say while progress in coping with risk may be limited, it's still ongoing. They cite interest in tail-risk protection and risk-based asset allocation as examples.
While some consultants insist the market's strength over the past two years has doused interest in efforts to hedge against “black swan” events, Vineer Bhansali, a managing director with Pacific Investment Management Co. LLC who heads the Newport Beach, Calif.-based company's tail-risk strategy, disagrees. PIMCO was awarded four or five major mandates last year and momentum is growing, he said. “Interest is huge. The pipeline is very large.”
Meanwhile, R. Bruce Myers, co-head of consulting with Cambridge Associates LLC, said even before the crisis, some of the Boston-based investment consultant's endowment and foundation clients were switching from a traditional asset class framework for asset allocation to one based on functional buckets such as growth, inflation hedging and liquidity. Post-crisis, “the speed of adoption has accelerated,” with many of Cambridge's largest clients adopting that change to some extent, he said.
The risk-bucket approach could facilitate another trend: U.S. institutional investors “have been adopting more tactical investment solutions to better arm themselves to withstand the volatility occurrences in the capital markets,” said Alan Dorsey, managing director and head of investment strategy and risk with Neuberger Berman LLC, New York.
In the strongly upward trending markets of the 1980s and '90s, there was more risk than reward in stepping outside an asset allocation framework for tactical reasons, but in the “choppy markets” of recent years, tactical asset allocation strategies have been enjoying considerable success, agreed Nancy Everett, a New York-based managing director with BlackRock Inc. and head of the firm's U.S. fiduciary management solutions business.
Cambridge Associates' Mr. Myers said a risk-bucket approach lends itself to more tactical flexibility, and that's one reason interest in the strategy has picked up.
Some pension executives who have made that switch say they're still working through the implications of the change.
Scott Simon, chief investment officer of the $3.2 billion Fire & Police Pension Association of Colorado, Greenwood Village, said his team anticipated far-ranging benefits from adopting risk-based allocations in 2010.
The new framework is still a work in progress, and the FPPAC team hasn't gotten to the point it had hoped to reach where understanding the “true risks” of the assets in the portfolio would set the stage for more tactical responses to capital market volatility, Mr. Simon said. The team is continuing to evaluate the new system, he added.
The pension fund has allocated 45% of assets to “global growth,” including equities; 31% to “risk reducers,” including fixed-income and absolute-return strategies; and 24% to “alternative growth” investments, including private equity.