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Pension Volatility Is Back ... (And It's Not My Fault!)

Mar. 06, 2018 3:04 PM ET

By Mike Clark, Consulting Actuary, the Principal Financial Group

In my January 24 blog, Market bull beats liability bear by a nose in 2017, I made a thoroughly actuarial comment that a liability driven investment (LDI) strategy can protect defined benefit (DB) plans against the risk of net loss in times of uncertainty. It seemed like a quaint thought at the time as market volatility had been on hiatus for almost two years.

Then, seemingly on cue, equity markets immediately cratered. The S&P 500 shed 10 percent between January 26 and February 8, technically satisfying the definition of a market correction.

Experts confirmed the slide was caused by concerns about inflation, and nothing directly attributable to any of my comments. (i.e., It's not my fault!)

Free pass?

A typical traditionally invested DB plan - say 60 percent equity and 40 percent core bonds - lost 2 to 3 percent on their funding ratio in those two weeks. This temporarily erased all the gains for the entire year of 2017.

Fortunately, markets have since regained their footing and corporate bond rates have risen, so the net impact of this turbulence has been relatively slight. Consider it a learning opportunity - a free refresher course on volatility without permanent damage to funding ratios.

Reconsidering LDI

Expectation of rising interest rates is often cited as a reason to postpone implementing an LDI strategy. (This is because shorter duration bonds generate positive net returns against pension liabilities when rates rise.) Hesitancy to exit a one-directional bull market is another.

These are certainly valid thoughts, particularly for underfunded plans. But if the correction indeed signals the dawn of a new era, one of rising rates and increased equity volatility, LDI may be worth another look.

Managing two risks

The move from a traditional to an

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The Principal Financial Group (The Principal®) is a global investment management leader offering retirement services, insurance solutions and asset management. The Principal offers businesses, individuals and institutional clients a wide range of financial products and services, including retirement, asset management and insurance through its diverse family of financial services companies. Founded in 1879 and a member of the FORTUNE 500®, the Principal Financial Group has $519.3 billion in assets under management1 and serves some 19.7 million customers worldwide from offices in Asia, Australia, Europe, Latin America and the United States. Principal Financial Group, Inc. is traded on the New York Stock Exchange under the ticker symbol PFG. For more information, visit www.principal.com. Insurance products issued by Principal National Life Insurance Co (except in NY) and Principal Life Insurance Co. Plan administrative services offered by Principal Life. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Princor Financial Services Corp., 800/247-1737, Member SIPC and/or independent broker/dealers. Principal National, Principal Life, Principal Funds Distributor, Inc. and Princor® are members of the Principal Financial Group®, Des Moines, IA 50392. Investing involves market risk, including possible loss of principal.

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