Corporate pension sponsors in the United States have a range of potential portfolio strategies and products to choose from. Vanguard recommends that these plan sponsors consider utilizing a liability-driven investing (LDI) framework to mitigate asset-liability risk.
The focal point of an LDI framework is the liability-hedging assets, which are typically composed of fixed income securities. But do all fixed income sectors have the same level of liability-hedging efficiency needed to manage asset-liability risk? We find that not all fixed income is created equal; in other words, a broad range of hedging efficiency exists. Certain sectors—namely U.S. investment-grade credit and U.S. Treasury bonds—are more efficient than others—such as non-U.S. bonds, TIPS, and securitized products—for hedging a typical corporate pension liability.
These less efficient fixed income sectors can potentially play a role in an LDI strategy, primarily the potential for higher returns relative to a plan's liability, as long as the plan sponsor is comfortable with the higher tracking error relative to that liability. Another important consideration is ensuring any allocation to less efficient sectors does not unintentionally reshape the overall characteristics of the liability-hedging portfolio.
All pension plans are unique and could merit a customized investment approach. With that said, foundational risk management principles span across most U.S. corporate pension plans. Attention to risk management is critical; maintaining a strategic focus and understanding all potential risks can help plan sponsors navigate uncertainty.
Note:
- All investing is subject to risk, including the possible loss of the money you invest.