Brian McDonnell, head of the global pension practice at Cambridge Associates LLC in Boston, said sponsors may need to build alternative risk strategies into portfolios to maintain funding and offset the ongoing costs of a diet.
The overall allocation to alternatives for the 100 largest business plans increased to 18% in 2021, from 15.3% the previous year.
He said defined benefit plans with longer time horizons can earn an illiquidity premium through private equity, private credit and other illiquid diversification strategies in the growth portfolio. There are also opportunities to allocate part of the fixed income portfolio to private credit, he said, although this may impact the plan’s discount rate coverage.
Several years of good asset returns and the impact of discount rate relief in 2021 have put corporate plans, overall, in a good funding position, McDonnell said. But market volatility in early 2022 is a reminder that yield-seeking plans will need to fully understand how alternative strategies focused on alpha, credit spread risk and interest rate risk can meet the needs of their particular portfolios. The level of risk and the type of risky assets should be adjusted to meet the needs of the business and the position of the individual sponsor’s plan, he said.
“We want every portfolio we work with to think about compensated risk. To know what equity risks we have, what discount rate risks we have and are we paid for it? ” he said.
McDonnell said plans that are less than fully funded and have an expected compound return in the 6% to 7% range in coming years will suffer from fixed income declines and equity market volatility. , as in the current environment, these portfolios will therefore need to be resilient and ready to rebalance based on opportunities, rather than liquidity needs, to achieve the expected return.
“So when we’re sitting here in times like this, we don’t have to sell the assets that are down. And when we’re sitting at market highs, we’re able to harvest risky assets to pay benefits and so on. It’s really about building a resilient portfolio to get through times like this,” McDonnell said.
Medtronic PLC’s 19.5% return on its US plan assets was the highest in the P&I universe. The plans had $3.66 billion in assets, up 22.8% from 2020, and $3.98 billion in liabilities, pushing the US plans to a funded ratio of 92% in 2021 against 80.1% a year earlier. The company’s closing date was April 30, 2021.
Eversource Energy, Springfield, Massachusetts, had the highest return among plans with a report date of December 31. Eversource returned 19.3% and ended the year with $6.5 billion in assets, 20% more than at the end of 2020. Plan liabilities fell 4.5% to $6.73 billion, with a 35 basis point increase in the discount rate. The funding situation improved by 19.7 percentage points to reach 96.5% at the end of the year.
HP Inc., Palo Alto, Calif., reported a return of $1.4 billion on $6.06 billion in assets as of the October 31 closing date. However, the plans started the year with $10.5 billion in assets. HP purchased a group annuity contract from Prudential Insurance Co. of America, funded by plan assets, which transferred approximately $5.2 billion in US pension plan liabilities during the company’s fourth fiscal quarter .
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