Defined benefit pension plan sponsors can improve their performance and risk assessment by closely evaluating the connection between assets and liabilities, said Jason Malinowski, chief investment officer at the Seattle City Employees’ Retirement System, during the Canadian Investment Review’s 2024 Investment Innovation Conference.
This is “because the portfolio return that changes your asset value is fundamentally linked and correlated to changes in expected portfolio return. These are not independent of one another; they’re connected.”
The SCERS, which was set up in 1929, represents firefighters and other non-police. Its plan assets are worth US$4 billion and, at the beginning of 2024, its funding status stood at 76 per cent.
Read: Bruce Power using asset-liability studies, rebalancing to protect pension fund
In early 2022, the plan’s asset perspective was challenging, said Malinowski, with the portfolio down almost 10 per cent in the worst performing year the investment organization experienced since the 2008/09 financial crisis.
“If I would’ve looked at the funding status, funding ratio of our portfolio and just updated the value of the assets, we would’ve faced a 13 per cent decline in our funding ratio. There was reason, from an asset perspective, to be concerned, to be scared.”
But after reviewing the liability side of the plan, he found there was significant activity in terms of a discount rate. An increase in interest rates, higher earnings yield in equities and higher rental yields helped build a projection of a 90-basis point improvement in long-term expected return.
“Asset values fell, but the expected portfolio return increased. What does that mean? That liability values also fell. From a total plan perspective, it wasn’t nearly as dire as just looking at the asset perspective.”
Read: 2023 Risk Management Conference: Interest rate lessons from the CBC Pension Plan’s LDI strategy
Through its liability-aware investing framework, Malinowski’s team recognizes a link between planned assets and liabilities, which changes the plan’s expected return. “It’s tailored to investors such as public pension plans that discount their liabilities based upon expected returns and it shifts the perspective from thinking only about asset volatility as a measure of risk to thinking about funded status volatility as a measure of risk.”
Plan administrators that consider this method can get a more complete picture of their plan status instead of just relying on portfolio performance, he said.
Also, Malinowski noted the SCERS is gradually shifting its investment approach away from what he determines are intermediate-term asset classes like core fixed income to long-term assets classes. The biggest change so far has been introducing a long-term fixed income allocation at a five per cent rate.
“We tend to [take an incrementalism approach] so I’d say this is the first move and I’d expect future moves going forward continue to fund more and more long-term asset classes from intermediate term.”
Read more coverage of the 2024 Investment Innovation Conference.