A new publication entitled “Dynamic Investment Strategies for Corporate Pension Funds in the Presence of Sponsor Risk,” produced as part of the BNP Paribas Investment Partners research chair on asset-liability management and institutional investment management at EDHEC-Risk Institute, shows that sophisticated dynamic allocation strategies can usefully be implemented by pension funds.
One of the key findings of the paper is to show that imposing a cap on the funding ratio, in addition to a floor, has a positive impact on both pensioners and bondholders, while only having a minor negative effect on equity value.
The paper introduces novel forms of dynamic strategies that recognise that pension risk is not only driven by the funding ratio of the pension fund, but also by the financial strength or weakness of the sponsor company. These strategies aim to control sponsor risk by avoiding states of the world where the pension fund is underfunded and the sponsor is unable to make up for the gap.
The paper analyses the benefits that arise from a variety of dynamic liability-driven investing strategies designed to maximise stakeholders’ welfare within an integrated asset-liability management context. It finds that implementing risk-controlled strategies aimed at insuring a minimum funding ratio level allows shareholders to gain access to the upside performance of risky assets, while ensuring that pensioners will not be overly hurt by the induced increase in risk.
Strategies that aim to control sponsor risk by providing insurance against the joint occurrence of an underfunded pension plan and a weak sponsor company are found under most circumstances to increase pensioners’ and bondholders’ welfare compared to basic CPPI strategies adapted to the asset-liability management context.
A copy of “Dynamic Investment Strategies for Corporate Pension Funds in the Presence of Sponsor Risk” can be downloaded via the following link:
EDHEC-Risk Publication Dynamic Investment Strategies for Corporate Pension Funds in the Presence of Sponsor Risk
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