New research from Greenwich Associates suggests that the U.S. asset management industry is on the brink of revolutionary change as pension plan sponsors look beyond their historic focus on asset growth and investment returns to more holistic strategies for funding pension liabilities.
This shift, which could portend radical disruptions for the investment management industry, is being driven by the confluence of two powerful trends: Under-funding and accounting reform, according to the research-based consulting firm. Under-funding poses a well-documented danger to defined benefit pension plans — a threat that will only grow as the U.S. workforce ages. Simultaneously, the transition to mark-to-market accounting rules in the United States is reducing the ability and willingness of corporate plan sponsors to tolerate market volatility within their pension funds, and thereby their ability to generate much-needed investment returns.
“Plan sponsors in both the public and corporate sectors have begun investigating a series of investment and management strategies, some new and some not-so-new, that are designed to achieve some combination of increasing investment returns, limiting portfolio volatility and managing liabilities down over time,” says Greenwich Associates consultant Dev Clifford.
According to the results of Greenwich Associates’ 2006 U.S. Investment Management Research Study, the departure from traditional pension management practices is most evident in the increasing popularity of innovative products and techniques such as liability-driven investment strategies, absolute return strategies, portable alpha and net-long approaches such as 120/20 and 130/30 strategies. “Although actual usage of these products remains relatively low, there are signs that the current period might well represent the calm before the storm,” comments Greenwich Associates consultant Rodger Smith. “Current interest rates make strategies such as liability immunisation expensive propositions, while strong global markets have boosted investment returns to the point at which many plan sponsors are now meeting their actuarial assumptions,” he adds.
Indeed, thanks to these conditions, average funding and solvency ratios improved over the past 12 months. “Even if such favorable market conditions persist, plan sponsors will continue to seek a different risk/return trade-off in their portfolios and new approaches and products will continue to gain adherents,” says Greenwich Associates consultant Chris McNickle. “Simply put, the two forces driving this change — under-funding and accounting reform — are not going away.”