Institutional Readiness for All Seasons

Many institutional investors and benefit plan sponsors are refining their investment and financial strategies to meet their objectives in the context of a shifting macroeconomic environment, including inflationary pressures, the Federal Reserve’s fiscal moves and continued economic effects from pandemic global supply-chain imbalances.

“If anything, the last 18 months has reminded us that volatility is a fact of life and being prepared for a range of economic and market scenarios puts you in a much better position to deliver on your mission,” said Keith McDonagh, head of the Institutional Solutions businesses at Massachusetts Mutual Life Insurance Company (MassMutual®). The institutional solutions group includes institutional investments, stable value, pension risk transfer, funding agreements, bank-owned life insurance and corporate-owned life insurance.

“While institutional clients are always trying to balance their needs for returns, liquidity and stability, we know those dynamics don’t converge simultaneously,” McDonagh said. In times of uncertainty, capital preservation usually takes a higher priority, while a stable or positive economic environment tends to place an emphasis on return-oriented solutions. “When you step back and look across economic cycles, you realize you can’t predict those periods. Many institutions now realize the need to be prepared for all scenarios.”

With the breakout of the pandemic and ensuing market uncertainty, institutions that placed greater focus on risk management and implemented tactical strategies to smooth volatility came out stronger than those that simply doubled down to preserve assets, McDonagh said. “This reflects [the need for] a change in investor mindsets, as there is now a more sophisticated understanding of the need for all-weather solutions that manage volatility while remaining focused on institutional goals and return optimization.”

For pension plans, the value of liability-driven investing
Many pension funds are more focused on refining their liability-driven investing (LDI), particularly in light of the strong performance in equities, which improved the funded status of many plans, McDonagh noted. “The benefits of LDI can often be overlooked in an environment where risk-on assets provide large returns. However, plan sponsors have the opportunity to lock-in funded status through an LDI strategy once their plans are well funded.”

How plan sponsors approach LDI depends on where they are on the journey, he added. So you need to ask, “How do you value aggregate return versus volatility minimization, and how do you manage these competing goals? By focusing on the concept and applying the principles, an LDI strategy can minimize volatility and provide appropriate levels of yield.”

Those plans that haven’t implemented an adequate LDI strategy are trying to understand whether they face a mismatch between their assets and liabilities and how that could shift in different economic environments, McDonagh said. “Is the funded ratio stable or is it at risk of deteriorating? And to what degree will the company have to fund the plan? Ultimately, LDI is about how best to ensure that the changing values of the pension fund’s investments and liabilities move in correlation.”

LDI is an integral part of the glidepath for plan sponsors contemplating pension risk transfer, along with hibernation or freezing the plan. “Many plans have considered pension risk transfer solutions over the past several years. For those that haven’t actively pursued a transaction, that interest has moved squarely to the forefront,” said McDonagh.

Investment diversification that balances stability with yield
On the defined contribution (DC) side, as plan sponsors consider a changing economic environment, they look to offer plan participants a balance of growth and capital preservation options, McDonagh said. “Equity solutions work nicely when paired with stable value, and together can provide a level of stability with a level of growth. When you look across market cycles, this type of diversification works effectively. We believe all defined contribution plans should offer solutions that balance those risks.”

Stable value solutions are seeing heightened interest, particularly for near retirees and those in retirement, as it helps reduce volatility and can provide stable income, McDonagh said. Stable value has long been a staple in DC plans, he noted, as a fixed-income vehicle that provides a guaranteed wrap that smooths the crediting rate — the effective annual yield — over time. While crediting rates are pressured in a low-interest rate environment, “offering a stable value option is an important decision for a fiduciary,” he said.

On the flip side of the yield-growth spectrum, DC plan sponsors have favored target-date funds and passively managed funds — both are solutions that see high usage by plan participants. In addition to those core strategies, many plan sponsors offer active and alpha-driven solutions in asset classes like small-cap equities and fixed income. “You need some of these solutions in your portfolio to try to outpace inflation, and an allocation that’s appropriate to a participant’s risk tolerance helps provide diversified returns,” McDonagh said.

This same diversification of investment solutions, with the right combination of yield solutions and volatility management, serves the needs of institutions for their own portfolios, he added.

Protection offerings to meet institutional needs
Institutions are showing increased interest in bank-owned life insurance (BOLI) and corporate-owned life insurance (COLI). BOLI/COLI policies provide life insurance coverage for a portion of an institution’s employee base, with their consent, to help fund employee benefit solutions, McDonagh explained. “These solutions offer either an attractive crediting rate from a highly-rated financial institution or access to various investment solutions, to efficiently fund benefit offerings and help retain key employees.”

While you can’t predict, you can prepare
Ultimately, all institutions need to be actively reviewing their financial and risk management strategies and solutions to be optimally positioned across diverse market environments. “While planning for the long-term can be difficult in the moment, the periods of disruption and uncertainty that we saw in the last 18 months serve as a reminder that a long-term view leads to more thoughtful decision making about which assets in the portfolio provide an attractive risk-adjusted return, offset troughs in the market when they occur and also capture some of the peaks,” McDonagh said. Experience in navigating across economic cycles helps institutions to ensure sustainable long-term success.

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