An Often Overlooked Truth

Pension plans should reduce surplus volatility as they work toward becoming better funded — at least, that is one school of thought. But there could be a fly in the ointment, argues Tony Gould, global head of pensions solutions and advisory at J.P. Morgan Asset Management in New York City.

In a recent column in Institutional Investor, Gould argues that what he calls “ill-constructed interest rate–hedging portfolios that ignore the correlation with return-seeking assets” are inefficient and could accomplish the opposite of the desired goal, and worsen surplus volatility as funded status improves. “That’s defined benefit plans’ often overlooked inconvenient truth,” he writes.

Gould posits that assets can show hedge and growth characteristics. And there is a symbiosis to hedging portfolios, and their ideal composition, and the composition of growth portfolios, he argues. To wit: How the ideal hedging portfolio is composed, he says, depends on the size and the composition of the growth portfolio. And the ideal composition of that portfolio depends on how big the hedging portfolio is, and how it composed.

Plan sponsors, Gould says, “should construct and manage pension portfolios holistically and not as two independent and uncorrelated buckets.” He adds that they should be mindful of risk and that there are variety of assets a plan can consider. “When constructing a portfolio to reduce funded status volatility, a manager needs to evaluate the different risks associated with each asset class for a holistic allocation” he writes.