Tag Archives: asset allocation

Developing an alpha beta allocation for your pension plan

In our recent article, “Developing an alpha beta pension plan portfolio,” we reviewed some of the basic concepts in developing allocations for pension plans. By using a combination of index and actively managed investments, known as an “core/satellite allocation,” a sponsor can diversify across a wide variety of asset classes and strategies while focusing on target return, volatility, and diversification.

The starting point, setting goals for the portfolio, allows for monitoring of the results, which include:

• Diversification: Overall allocation across classes, as well as correlation of returns
• Target return: The desired annualized return to meet retirement goal requirements
• Management expenses: The investment manager expense

Index investments represent the beta, or the market return that is the basis of the portfolio. Active managers can be used to generate the alpha, returns in excess of the market (or index) return. Also, active managers can be used to moderate downside risk in declining markets. The combination of the two approaches can be a prudent strategy in developing an alpha beta portfolio.

Pension plan investment returns: Some thoughts and observations

With market volatility of stocks very apparent these days and interest rates on fixed income investments at historic lows, what can a plan sponsor, or the investment committee, of a defined benefit pension plan do to manage portfolio returns?

Asset allocation
We’ve all heard that asset allocation is one of the most important drivers in the return of an investment portfolio. One of the often overlooked aspects of this is setting a rebalancing policy, too. When equities gain value, pushing that side of the portfolio outside of preset allocation ranges, having a rebalancing policy allows the portfolio to capture some of the gains and bring the expected risk/return profile of the plan back into the defined targets. This can be as simple as noting in the policy that if an asset category moves more than 5% above its stated target weight in the portfolio, some will be trimmed and reinvested among the other assets that are presumably under-weighted.

Look at plan expenses
If the plan allocates expenses related to plan administration to the investment portfolio, it is good fiduciary practice to look at those expenses and determine if they are reasonable and fair.

Where are some areas to look?

  • Trust/custody services
    • You may have a good relationship with your trustee/custodian and they may do great work. But are the fees fair for the services provided?
    • Have assets grown since you switched providers? Your fee may be based on asset size and may have gone up as well.
    • Take a look at other providers, or consider asking your current provider for a discount.
  • Investment management fees (this has a lot of avenues to look at!)
    • Are you in the right vehicle? Based on the plan size, what is a good investment: mutual fund, ETF, separate account?
    • For the investment, is the expense fair compared to other managers in the category?
    • Is your manager or consultant getting “soft dollars” for sending assets or trades to a certain manager/brokerage?

Asset allocation is important; it does drive the return and level of risk of the portfolio. Keep an eye on this and set a policy for monitoring and for when rebalancing occurs. Much scrutiny has been placed on defined contribution (DC) plan expenses as of late and little emphasis on defined benefit plans. As a fiduciary, you need to keep an eye on expenses for your defined benefit plan as well. This is especially true if they are being passed through and paid from the investment trust, because they are directly affecting the return of the portfolio. I’ve written a number of DC plan fiduciary-related articles, and now it’s on to DB this year, so stay tuned.

How did you respond to recent volatility?

When the financial markets closed on Aug 15th, the stock market had recouped all of its losses from the previous horrific week of volcanic volatility.  Three-year and five-year Dow Jones and S&P500 returns were either flat or negative.

The Investment Company Institute reported that over $50 billion moved into money market funds in the week ended August 10, but the cumulative change in the prior three weeks was a $130 billion outflow from money market funds.

The Wall Street Journal reported that the wealthy no longer have an appetite for the risk of equities and are “hunkering down with cash, gold, farmland and other safe-haven investments.”

Many financial advisors recommend staying the course with a diverse portfolio including, among other investment options, target date funds.

How are corporate pensions approaching asset allocation?

Reuters looks at how corporate pensions are taking a longer-term approach to their inestments. Here is an excerpt:

Pension funds are buying more bonds and paring investments in stocks in the aftermath of the financial crisis as more baby boomers seek safer investments ahead of retirement.

The oldest of the baby boomers, the millions of Americans born between 1946 and 1964 in the population boom after World War II, will turn 65 next year.

Trends for 2009 and 2010 so far indicate that allocating 60 percent to equities — standard for pensions before the market collapse of 2008 — may never return, according to the author of an annual study on the subject.

Corporate pension plans are likely to trim exposure to stocks to about 50 percent and permanently raise allocations to bonds to roughly 35 percent — up from 30 percent before the global financial crisis, said John Ehrhardt, the study’s main author. He is principal and consulting actuary in New York at Milliman Inc., an employee benefits consulting firm.

Even after U.S. stock markets rebounded last year, equity allocations rose by the end of 2009 to just 46 percent from 44 percent at the end of 2008, according to the annual Milliman Study of defined benefit pension plans at publicly traded companies, accounting for total assets of $1.088 trillion.