The Pension Fund's De-Risking Trigger
A $900M defined-benefit plan has a funded ratio of 96%. The board adopted a glidepath: at 100% funded, shift from 65/35 equities/bonds to 50/50; at 105%, shift to 35/65. The plan's actuary reports that liabilities have a duration of 13 years, while the bond portfolio has a duration of 6 years. Equity markets have rallied 14% this year, and the funded ratio now sits at 100.4% on a market basis. The CIO notes that the 50/50 trigger is based on a smoothed funded ratio measured at fiscal year-end, three months away. Two trustees want to act immediately; the sponsor (the plan's corporate parent) is under cash-flow pressure and would prefer to defer contributions.
1. Should the plan act on the market-based 100.4% funded ratio now or wait for the fiscal year-end smoothed measurement? Frame the decision in terms of the plan's own policy and the risks of each path.
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The policy specifies a smoothed funded ratio measured at fiscal year-end, so acting on the market-based 100.4% figure would be a discretionary override of the governing document. That override is defensible only if the board formally amends the policy; otherwise the CIO is making an ad hoc timing call that invites second-guessing later.
Key considerations:
- Trigger is not yet met under policy. 100.4% market-based, measured three months early, is not the metric the glidepath references. Market values can reverse before year-end; a 14% equity rally could give back a meaningful fraction.
- Cost of waiting is asymmetric in one direction: if equities keep rising, the plan de-risks from a higher funded ratio (good), but if equities fall, the plan stays at 65/35 and the funded ratio erodes (bad). The glidepath's whole purpose is to lock in gains as they accrue.
- Cost of acting early is a policy precedent: if the board overrides the smoothing rule once, the smoothing discipline is weakened and future triggers become negotiable.
The disciplined answer: do not override the policy on the market number, but pre-commit - instruct staff to compute the year-end smoothed ratio and pre-authorize the 50/50 shift if it meets 100%, so the decision is automatic rather than a fresh debate. Separately, flag to the board that the smoothing lag is a known weakness and consider a mid-year check provision. The sponsor's cash-flow preference is not a fiduciary consideration for the investment decision and should not drive the glidepath timing.
2. The bond portfolio's duration (6) is far short of the liability duration (13). If the 50/50 shift happens, how well does the new allocation hedge the liabilities, and what does that imply for the glidepath's design?
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At 50/50, the interest-rate hedge ratio is roughly (bond weight × bond duration) / liability duration = (0.50 × 6) / 13 ≈ 23%. Even after de-risking, the plan remains heavily exposed to rate-driven liability growth: a 100bp fall in rates raises liabilities ~13% while the bond sleeve gains only ~3% of total assets, widening the deficit.
Implications:
- The glidepath shifts equity risk down but does not meaningfully hedge liabilities. It reduces surplus volatility from equities while leaving a large duration gap. That is a defensible choice only if the board understands it.
- A proper liability-driven design would lengthen the bond portfolio's duration (long corporates, STRIPS, or a completion portfolio) so the hedge ratio rises as the funded ratio rises - e.g., at 105% funded, target a hedge ratio of 60–80%.
- The current glidepath can produce a bad outcome: funded ratio hits 100%, plan de-risks into short-duration bonds, rates fall, liabilities balloon, and the plan is worse off than if it had hedged properly.
Recommendation: before executing the 50/50 shift, the board should be told the hedge ratio is ~23% and decide whether to pair the equity reduction with a duration-extension program. The glidepath and the LDI strategy must be designed together; treating them as separate decisions is the error.