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Pensions looking to curb costs and reduce risk, says Vanguard research

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Corporate pension plan sponsors are increasingly focused on curbing plan costs amidst challenging market and regulatory environments, including low interest rates, longer life expectancies, and rising premiums, according to Vanguard research.

Vanguard’s latest survey of defined benefit plan sponsors found that plan costs was the top concern among the more than 175 pension managers surveyed, followed closely by funded status risk.
 
Moreover, these concerns are driving priority investment objectives, which defined benefit (DB) plan sponsors overwhelmingly identified as minimising cash contributions and reducing funding status volatility. However, in stark contrast, sponsors are under mounting pressure to ensure their plans meet funding requirements either through cash contributions or return-generating asset allocations in the portfolio – the latter of which can expose the pension to increased funding volatility.
 
“Our research has continued to point to a trend of cost reduction and risk management across the pension industry,” says Kimberly Stockton (pictured), an analyst in Vanguard Investment Strategy Group and author of the paper. “Yet, there’s a continued disconnect between these crucial objectives and existing portfolio construction. There is an opportunity for plan sponsors to implement strategic asset allocations to better protect themselves from unexpected costs and risk.”
 
Despite a growing number of frozen plans, the average asset allocation reported in 2015 was almost identical to 2012: 48 per cent equities, 39 per cent bonds, 2 per cent cash, and 11 per cent alternatives. The 2015 DB survey respondents with frozen plans reported an average funded status of 84 per cent, likely influencing the outsized equity allocations. However, 32 per cent of frozen plans also signalled a planned termination in the next several years, suggesting that portfolios might still be assuming too much risk.
 
While the average allocation to fixed income was unchanged, the types of fixed income products that plan sponsors are using shifted slightly towards longer-duration products that better match plan liabilities. Despite this emerging trend, there is room for improvement. For plans with larger return-seeking allocations, Vanguard believes that the fixed income allocation – the liability-hedging allocation – should be at least duration-matched.
 
An important component of a liability-driven investment strategy is managing funding ratio volatility, and sponsors identified this as a top investment objective. As such, the vast majority of surveyed sponsors believe that only a 1-10 per cent variance in plan-funding ratio is acceptable. However, Vanguard’s analysis found that the average asset allocation was well beyond the 10 per cent variability threshold, suggesting that investment strategies are not appropriately aligned with risk tolerances.
 
Vanguard’s report reflects a long-term industry trend of declining open and active plans, with the number of frozen plans nearly doubling in the past five years. However, there is also a meaningful portion of plan sponsors that are committed to offering a pension over the long-term. Of the 30 per cent of plan sponsors who reported having open, active plans, 86 per cent said they continue to value the plan as a recruiting and retention tool. Despite different end goals and approaches to investment management, cost concerns were universal across both the closed and active sponsor segments.
 
“Regardless of plan design phase, we are hearing from plan sponsors that there is a great need for guidance in today’s challenging world of pension management. Portfolios need to be risk-appropriate, designed to achieve and maintain full funding, and aligned with your overall strategy – all with an eye toward costs,” says Christopher Philips, head of Vanguard Institutional Advisory Services, which serves defined benefit plans and other institutional investors.
 
“In an unpredictable market environment, we encourage plan sponsors to focus on the areas within their control: The fees they pay for their plans’ investment products and the fees they pay for advice.”

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