By Nick Thornton
Corporate Defined Benefit Plans have benefited from 2013’s huge market gains in equities
. Funding ratios, which gauge assets relative to liabilities, have improved by 11 percent for the average corporate pension fund, according to a research paper released by PIMCO entitled “De-Risking Pensions in a Time of Tapering.”
Rene Martel and Markus Aakko, both executive vice-presidents for the Newport, Ca., based global investment management firm, co-authored the paper, which cites the Milliman 100 Pension Funding Index as proof of improved funding in corporate defined benefit pension plans
And while this is a good problem to have, the question going forward is what to do with the gains. Many pensions plans, according to the PIMCO paper, have a preset “glide path” that calls on riskier assets to be reinvested into safer instruments after a period of improved funding.
With interest rates at or near all-time lows, plan sponsors, rightfully concerned about rising rates, may be hesitant to take the substantial gains in equities and reinvest them in fixed-income allocations.
The PIMCO paper suggests that pensions consider breaking up the de-risking process into two steps, allowing for risk-reduction from equities while maintaining flexibility relative to the purchase of long-duration bonds.
Corporate bonds historically have been used as de-risking instruments. Their current historic low yields create a dilemma for plan sponsors, according to the paper. Hence, a reasonable instinct to delay the de-risking process.
But history proves that hesitation, while understandable, can be very painful to corporate pension plans. The PIMCO paper cites data from corporate plan funding ratios over the last two decades. Typically, it has taken about five years for funding ratios to move from their lows to their highs in periods of strong market performance. Conversely, the data shows that it only takes 18-24 months to reverse those gains. According to this data, it takes longer for corporate pension funds to make money than it does for them to lose money.
Some plans may be required to de-risk given the recent improvements in their funding ratios
, in which case the PIMCO paper recommends “any reduction in equity and other return-seeking assets should be implemented in short order to lock in significant recent market gains.”
Originally published on BenefitsPro.com