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Rising equities, low interest rates create split in derisking approaches

Michael Moran GSAM
Michael Moran says we see from a lot of plans a little bit of a struggle.

An improvement in defined benefit plan funding has triggered a tension within corporations between an investment outlook to pursue rising equity markets and risk management in pursuit of better asset-liability matching in spite of low interest rates, said Michael A. Moran, pension strategist, Goldman Sachs Asset Management LP, New York.

Many sponsors “have a glidepath in place that says as funded levels go up they should be increasing fixed-income allocation, extending duration, better matching,” Mr. Moran said in an interview. “But there is a very strong view of many people out there that interest rates are going to head higher.” As a result, “a number of clients have indicated that in some cases they are holding off on (moving up) this glidepath.”

“Some plans when they look out … at prospective returns across equities and fixed income … feel like equities will perform better and therefore (ask) why would I want to make the shift now” to more fixed income on a derisking course and away from return-seeking equities, Mr. Moran said.

“There is definitely a tension between the investment view on the markets and the risk management exercise of better asset-liability matching,” Mr. Moran said. “So we see from a lot of plans a little bit of a struggle where according to their glidepath they should be starting to shift asset allocation now. But they have this view of the market that equities are going to outperform bonds. They don't want to do it yet” and move up the glidepath to more in fixed income.

“So there is a tension between sort of the risk management angle as well as the pure investment angle,” Mr. Moran said.

What will trigger a decision?

“For those organizations where the pension obligation is very large in relation to the sponsoring entity, they are very exposed to the volatility of the funded status in their (corporate) balance sheet, income statement and cash flow statement,” Mr. Moran said. “They probably have more incentive …as funded levels rise,” to derisk or better hedge the liability because “if equities markets were to correct or interest rates head south (they'd) see a decline in funded status. What that would mean from a sponsor perspective could be pretty punitive.”

“We like to say materiality trumps everything. The more material the plan the more incentive you have to take more of a risk management approach,” Mr. Moran said.

But “a plan isn't really that large (in relation) to an organization and … can withstand funded-status volatility, (so) maybe” it can take “more of a pure investment approach, because if it doesn't work out, if funded states declines, it's not going to be onerous on the sponsor results.”