Why the fountain of youth would unleash a flood of liabilities
Feb 7th, 2008 | Filed under: Institutional Investing
Let’s say you’re saving for retirement and you plan to live to the ripe old age of 85. You save accordingly by socking away a certain amount every year and banking on the market to provide you with a tail wind to help you built just the right sized nest egg. To your delight, your portfolio seems to be beating the S&P 500 year after year. Way to go, fella!
Then one day, magician David Copperfield announces that his quest for the fountain of youth has finally yielded some results. He has scientific evidence that the stream running through his Bahamian plantation will allow anyone on Earth life to the age of 100.
“Damn that Copperfield!” you exclaim. Now you have to save a lot more for retirement than you had planned. All of a sudden, beating the S&P 500 ain’t looking so hot anymore, eh? You’re now on the hook to support yourself for an extra 15 years.
Pension plans face this problem all the time. In fact, a scan of FTSE 100 companies this week reveals that 10% of them had to raise their expectations of longevity this year alone - significantly increasing their future liabilities.
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I am SHOCKED! SHOCKED to find that actuaries engage in hocus-pocus!
“Mr. [Chris] Levell [of New England Pension Consultants] said a third of NEPC’s corporate clients have done some liability-driven investing, a figure that should push toward half by the end of 2008, despite the unfavorable moves in the equity and credit markets.â€
Is it safe to say that “some liability-driven investing” is a misnomer. LDI is a strategic decision for a pension plan and must be managed on a portfolio level. Earmarking some funds as LDI funds is incongruent with the strategy.
Uh, Merrill and Lehman (and I think UBS, too) came out with Liability-Driven Investing indices last year, some with backdated returns going back decades. So NTRS is not doing anything particularly new.
Prof. Miles Zvi has been on this track for years. I don’t understand why more pensions (corporate and government) haven’t done this. The biggest enemy of a pension is not having enough in long-dated bonds, regardless of interest rate levels. A matched-duration strategy means that even if rates rise, hurting the portfolio, the liabilities decline, because they are discounted at a higher rate. If anything, actuarial smoothing should be reduced so plans aren’t made in another galaxy when Treasury rates were at 6%…
Sorry, in my Feb. 9 comment, make that Zvi Bodie, prof. of mgmt at Boston University, not Miles Zvi.
The PBGC’s dramatic increase in equity allocation announced 2/18 provides an interesting additional aspect this this discussion. They had been 28% equities, no going to 45%. Their bond returns for 2006 were +3.47%, which suggests they did a HORRIBLE job managing their duration. Why weren’t they more in long AAA and/or long Tsy assets? Their liabilities are way the heck out in the future. Long govvies were up 8-11% in 2007.