Pension plan de-risking in 2024: golden opportunity? There are solid reasons to believe that should be the case, if today’s market conditions persist. This should be good news for long bond managers (and PRT players too?)
Today is the first business day of the fourth quarter. And it is the time most pension plans and insurance companies start their asset allocation discussion and planning for the next year. It was supposed to be a routine exercise. However, given the dramatic changes in market conditions, the asset allocation decision has been anything but routine.
Last year we experienced a dramatic yield rise and equity market sell off. It was a tough market for asset owners. For pension plans, on the other hand, the more than 200bps of rise in liability discount rate drove the liability present value down more than the loss on assets. As a result, most plans saw their funded ratio improve by 5% to 10%, ending the year with funded ratios around the 100% fully funded mark. Why did this not translate to a wave of de-risking this year? I believe the following factors contributed to the lack of de-risking activity in 2023 YTD:
- The equity market valuation was perceived to be too low, given the significant drop in the equity market. Plans did not what to lock in the loss in their equity investments.
- Plans need some funded ratio buffer over the fully funded mark to cover other expenses.
What is different now?
- The market yield is 70bps higher now (9/29/2023) than the beginning of the year, measured by either the long Treasury rates or the FTSE pension discount rates. This translates to a funded ratio improvement of 3~5% for a typical traditional DB plan.
- The 12% rise in the equity market gain YTD (9/29/2023) should have also added another 3~5% of funded ratio improvement.
- These two factors should result in a funded ratio improvement of 6~10% by year-end 2023, if the market conditions persist. This should provide sufficient buffer for de-risking. And the higher level of equity market and higher bond yield also make it much easier psychologically to reduce equity allocation and re-deploy assets in fixed income. The hit on ROA will not be as significant as during the low yield days.
