Liability-Driven Investing Served Pension Funds Better Than Traditional Allocations in 2008
February 02 2009 - 12:02PM
PR Newswire (US)
WASHINGTON, Feb. 2 /PRNewswire/ -- Pension funds that used
so-called liability-driven investment (LDI) strategies outperformed
funds with traditional asset allocations in 2008 by a significant
margin, according to Watson Wyatt, a leading global consulting
firm. LDI strategies seek to reduce pension funding volatility by
aligning investments more closely with plan liabilities (in the
form of future payments to retirees). Typically, LDI emphasizes the
use of long-duration bonds, liability hedges and asset
diversification while lowering exposure to equities. Portfolios
using LDI strategies likely had returns in the range of negative
single digits to break-even, while traditional asset allocation
strategies likely yielded 20 to 30 percent losses or more. A set of
hypothetical portfolios -- one LDI and one traditional(1) --
constructed by Watson Wyatt in December 2007 and tracked on a
monthly basis demonstrates the sharp difference in returns. For
2008, the hypothetical LDI portfolio broke even, while the
traditional portfolio suffered a 25 percent loss. "New accounting
and pension rules -- and the desire for more predictable returns --
have prompted some companies to adopt LDI strategies in recent
years," says Carl Hess, global head of investment consulting at
Watson Wyatt. "LDI served those companies well in 2008. "However,
most companies are still using traditional allocations or are in
the process of phasing in LDI strategies. Unfortunately, options
are more limited for now, as hedging opportunities have dwindled
with the credit crisis, and market volatility makes big investment
moves risky." The emphasis on long-term bonds and liability hedges
paid off handsomely last year -- the long duration bond benchmark
was up more than 8 percent in 2008, and interest rate swaps
performed even better, with some returns in excess of 30 percent.
But asset diversification worked less well. That's because most
securities -- U.S. large and small caps, international equity and
even real estate and hedge funds -- declined in value together.
However, there was some value in diversification, as alternative
asset classes generally did not have the same magnitude of declines
and hedge funds continued to aid risk control. "Although the
liability hedge worked in 2008, last year's high positive returns
on swaps and long bonds will not likely continue going forward,"
said Mark Ruloff, director of asset allocation at Watson Wyatt.
"Despite this, the full range of liability hedging options has
gained new credibility, and the recent financial turmoil has proved
that its appropriate use has a definite value in controlling and
managing risk." To view Watson Wyatt's Funded Status Watch Report
and its methodology, please go to:
http://www.watsonwyatt.com/Mailing_Data/investmentbrief/funded_status_watch.ht
m (1) The traditional portfolio has an asset allocation based on
median market survey statistics of U.S. corporate DB plans with
more than $1 billion in assets. The other portfolio incorporates
two of Watson Wyatt's key investment building blocks --
liability-driven investment (LDI) and beta diversity. About Watson
Wyatt Investment Consulting Watson Wyatt Investment Consulting, a
division of Watson Wyatt, is focused on creating financial value
for institutional investors through independent, best-in-class
investment advice. We are specialist investment professionals who
provide coordinated investment strategy advice based on expertise
in risk assessment, strategic asset allocation and investment
manager selection. Watson Wyatt Investment Consulting provides
investment advice to some of the world's largest pension funds and
institutional investors, and has more than 550 associates in
Europe, the Americas and Asia. In the United States, investment
advisory and investment consulting services are provided by Watson
Wyatt Investment Consulting, Inc., which is a subsidiary of Watson
Wyatt Worldwide Inc. Watson Wyatt Investment Consulting, Inc., is a
registered investment adviser with the Securities and Exchange
Commission. About Watson Wyatt Watson Wyatt (NYSE:WWNASDAQ:WW) is
the trusted business partner to the world's leading organizations
on people and financial issues. The firm's global services include:
managing the cost and effectiveness of employee benefit programs;
developing attraction, retention and reward strategies; advising
pension plan sponsors and other institutions on optimal investment
strategies; providing strategic and financial advice to insurance
and financial services companies; and delivering related
technology, outsourcing and data services. Watson Wyatt has 7,700
associates in 32 countries and is located on the Web at
http://www.watsonwyatt.com/. DATASOURCE: Watson Wyatt CONTACT: Ed
Emerman for Watson Wyatt, +1-609-275-5162, ; or Steve Arnoff of
Watson Wyatt, +1-703-258-7634, Web Site:
http://www.watsonwyatt.com/
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