Corporate Pensions are Looking to Make Changes to Liability-Driven Investment Allocations

Franklin Templeton commissions first landscape study since 2019 showing many plans are now fully funded, fueling a fresh evaluation of many pensions’ LDI programs

A new study commissioned by Franklin Templeton and conducted by Coalition Greenwich reveals corporate pension plans are signaling changes to their liability-driven investment (LDI) approaches in the current interest rate environment. The first dedicated Corporate Defined Benefit (DB) LDI research in over five years marks a distinct inflection point in pension plan management strategy and LDI approaches of the top US Corporate DB plans.

After the global financial crisis in 2008, funded status of corporate pension plans plunged from around 100 percent to only 80 percent—erasing years of hard-fought gains. It has taken more than a decade for most plans to slowly climb back to healthier funded status levels—the average pension was just 88 percent funded at the end of 2020. But the rise in interest rates has resulted in many corporate DB plans reaching fully-funded status, now 104 percent on average, in less than two years—creating a critical opportunity to further de-risk their portfolios.¹

According to the Coalition Greenwich study findings, 73 percent of pension plans report funding ratios of 100 percent or higher while 23 percent report funding ratios in excess of 110 percent. The challenge pension funds now face is preserving these healthy funding levels with 70 percent of plans in the study indicating that protecting funded status at current levels is a top investment priority compared to 20 percent of plans that cite generating returns to maximize funded status as their top investment priority.

“We have seen a dramatic shift in the funding ratio over a short period of time and now is the time for corporate pension plans to review their LDI portfolios to ensure they are properly diversified and have adequate downside protection,” said Timothy Quagliarello, senior client advisor, Franklin Templeton Institutional. “Maintaining funded status is critical and continuing to methodically de-risk a portfolio is important to help protect the great progress corporate pensions have made over the last few years.”

Many pension plans indicated that a reevaluation of their current LDI manager line-ups may be necessary. About half were concerned with “substantial overlap in holdings” among their LDI managers, and nearly a third cited inadequate downside protection when markets sell-off, higher correlations between managers, and off-benchmark exposures like high yield presented a key risk in their current allocations. Approximately 30 percent of study participants indicated they are contemplating a change to LDI strategies—a significant share considering the very long-term nature of DB portfolios. Of those contemplating changes, 44 percent indicate wanting to improve downside risk protection. Furthermore, when asked about the most important qualities when selecting an LDI manager, risk management (96 percent), fees (70 percent) and knowledge of key pension risk management elements (70 percent) ranked highest.

“While rising interest rates were a windfall for corporate funding ratios over the past few years, we think protecting the hard-earned gains requires a change to how plan sponsors select managers and design their liability hedging allocations,” said Tom Meyers, senior director of investments, Franklin Templeton Fixed Income. “We believe that many pension plans review managers on a singular basis, and sometimes overlook that it’s the mix of managers that is most important. Owning all the best managers may not make for the best portfolio. Once you understand what each manager is delivering and how they are generating returns, many plans find that they are actually doubling down on the types of strategies with the same types of vulnerabilities. We believe it’s best to find the right mix of managers that complement each other’s strengths to deliver both enhanced diversification and downside mitigation to an existing multi-manager hedging allocation.”

Corporate DB plans are entering a new phase of pension management. The past decade was marked by growth as the top priority, but the rapid rise in interest rates has put many corporate pensions in an advantageous funding position, making safeguarding those gains the top priority of this next phase. Consequently, multi-manager LDI hedging allocations need to evolve to further reduce funded status volatility and help prepare pension plans for end game scenarios like hibernation or annuitization.

More detailed information on the study can be found at the Coalition Greenwich website or visit the Franklin Templeton website to connect and learn more.

¹ Source: Milliman, 2023 Corporate Pension Funding Study, as of September 30, 2023. The Milliman 100 Pension Funding Index tracks the funded status of 100 U.S. public companies sponsoring the largest defined benefit (DB) pension plans.

Survey Methodology

From August through October 2023, Coalition Greenwich conducted 30 interviews with institutional investors targeting key decision-makers at corporate DB plans based in the United States to understand how they manage diversification and plan/fund risk, select an LDI manager and navigate overall risks on the economic horizon. As part of the study, Coalition Greenwich also held in-depth discussion with some of the world’s biggest and most prominent investment consultants. The bespoke study was commissioned by Franklin Templeton. Coalition Greenwich and CRISIL Ltd are not affiliated with Franklin Templeton.

About Franklin Templeton

Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives and multi-asset solutions. With more than 1,300 investment professionals, and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and over $1.3 trillion in assets under management as of October 31, 2023. For more information, please visit franklintempleton.com and follow us on LinkedIn, Twitter and Facebook.

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