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A factors-first approach to efficiently growing assets in the surplus space

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Corporate pension plans’ top priority: Building efficient portfolios in the surplus space

The median funded ratio of pension plans sponsored by S&P 500 companies was just 83% as of 30 Sep 2020.1 This highlights the need for corporate pensions to grow their assets efficiently while generating cash flows to deliver the promised benefits to plan participants — a dual mandate that is increasingly daunting in an environment of muted return expectations.

While some well-funded plans may be adequately positioned to deliver on their near-term liabilities, our analysis of typical portfolios used by well-funded, moderately funded and poorly funded corporate plans found that none of these cohorts are growing their assets efficiently in the surplus space.

Why are many corporate pension plans across funding levels building suboptimal portfolios? We believe this is because they have not embraced a factors-first approach to portfolio construction.

A factors-first approach centers on the idea that investors should focus on identifying which combination of risk factors the portfolio needs to own to optimize the growth of assets relative to the growth of liabilities. The portfolio’s asset allocation then becomes a byproduct of the targeted factor exposure.

Figure 1 Typical portfolios exacerbate shortfalls

Using the factors-first lens, we examine ways that corporate pension plans at various funding levels can optimize their approaches to portfolio construction. While most of our findings and recommendations focus on moderately funded plans (funding ratios between 80% and 90%) and the optimization techniques available to them, most of these approaches can be useful for plans at either end of the funding ratio spectrum, as well. We also address special considerations for well-funded and poorly funded plans.

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1 Goldman Sachs Asset Management, “Corporate Pension Quarterly Q3 2020.” https://www.gsam.com/content/gsam/us/en/institutions/market-insights/gsam-insights/pension-solutions/2020/Corporate-pension-quarterly-q3-2020.html