Buck Bond Group
2022 Silver lining for defined benefit plan investors

2022 Silver lining for defined benefit plan investors

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Dark clouds loom for 2022 asset returns: S&P 500 falling into -20% bear market territory in June, international equities have fallen -19.6% partially thanks to a strengthening dollar. Long Gov/Credit bond returns are also down more than 20% through August as yields have increased in short- and long-dated maturities by 316bps and 176bps, respectively. (Chart 1)

Chart 1: Change in Buck AAA/AA Corporate Bond Spot rates from 12/31/2021 to 8/31/2022

The silver lining for defined benefit plans is that the funded status increased in 2022 for most plans with hedge ratios less than 100%, despite the losses on the asset side.

2022 funded ratio improvement examples

Let’s consider a hypothetical plan that is 100% funded at 12/31/2021 with a liability duration of 16 years, a strategic asset allocation of 40% Long Gov/Credit (i.e. a hedge ratio of 38.5%), and a hypothetical return-seeking drawdown of 20%. (Table 1)

Table 1: Funded ratio improvement for a plan invested with an allocation of 40% Long Gov/Credit

*This simple example ignores convexity

This example demonstrates how beneficial the rise in rates in 2022 has been for the funded status of many defined benefit plans.

As demonstrated by another hypothetical plan with a traditional 60% Diversified Return-Seeking/40% Aggregate Bond allocation, the funded status improved from 100% to 107% as assets outperformed liabilities in 2022 despite drawdowns in equities and bonds. (Chart 2)

Chart 2: Outperformance of assets over liabilities and funded ratio improvement for a plan invested with an allocation of 60% Diversified Return-Seeking/40% Aggregate Bonds

The higher yield on bonds in 2022 has created an attractive time to lock in funded status gains.  Due to Federal Open Market Committee actions responding to COVID, short-term treasuries had an expected yield close to 0% before 2022, which forced investors to allocate to stocks with higher expected returns.  Now with 1-year bond Treasury yields above 4% (as of 9/19/2022) bonds now yield more than the dividends on most stocks.

The silver lining

Given the magnitude of changes in capital markets during 2022 of yields, equity valuations, and funded status, now is an ideal time to review the plan’s strategic asset allocation with an asset liability study.  Changes in both the allocation to fixed income and the duration of the fixed income portfolio should be considered to reduce funded status volatility and to lock in the 2022 funded status gain.  In addition, plan objectives should be reviewed in the context of the opportunities presented by the 2022 silver lining, which currently provides opportunities for hibernation, pension-risk transfer, or even termination.

An increase in funded status is a favorable outcome despite market volatility in 2022.  Volatile conditions are expected to persist with many economic indicators pointing to the US already in a recession.  Given it’s impossible to time the market perfectly, we believe when the market gives you a gift, you should take it – now is the time to prepare for any potential future storms.



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