Pension Trends for 2014

Plans are looking at creative ways to mitigate liability exposures, including derivative hedging strategies.

Ledford_Main image_v2In 2013, the funded status improved dramatically for most pension plans in the United States. Still, many analysts expect pension de-risking to continue this year. Some plan sponsors will likely offer lump-sum buyouts to participants. Others are reconsidering their asset allocations.

To get a handle on current trends in pension plan risk management, Treasury & Risk sat down with Jodan Ledford, head of U.S. solutions for Legal & General Investment Management America (LGIMA), a Chicago-based firm that manages fixed-income solutions for institutional investors. The organization also helps plan sponsors implement liability-driven investment (LDI) strategies, which focus on investing plan assets in vehicles that will optimally mitigate the risks inherent in the plan’s liabilities.

So we worked with that plan sponsor to target a 100 percent interest rate hedge ratio and a 60 percent credit spread hedge ratio. What that means is, over the quarter, we wanted to match the liability return with respect to changes in interest rates, dollar for dollar. So if the liabilities change by $100 solely due to interest rates, we want to have a $100 return from our customized portfolio. And also, in conjunction with that, we want to match 60 percent of the change due to credit spreads. So if credit spreads widen and liabilities go down by $50, we'd want to have a $30 loss in our hedging portfolio.

The idea is, when you actually decompose how the liabilities changed over the quarter with respect to each of the risk factors, and add those up, you’ll get the dollar return amount you’re looking for. Then if you use that dollar return against your beginning-of-period value for liabilities, you’ll have a liability benchmark of X percent. That’s what we’re trying to match when we talk about a customized portfolio.

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