Strategic asset allocation – Liability benchmarking and dynamic risk budgeting

Abstract

Pensions Vol. 10, 2, 111–118 The debate on reforming pension fund best practice has raged now for over three years, with more attention devoted to defined benefit (DB) than defined contribution (DC) plans. The pension fund industry has carefully managed the relatively small risk between the portfolio and its benchmark while ignoring the much larger risk between the benchmark and the plan's liabilities. This paper proposes a more general optimal portfolio solution which explicitly takes into account a fund's shifting wealth (or funding ratio) and risk premia. This new approach leads to a path-dependent process directly linked to a fund's liabilities and suggests ways in which best practice should be modified. It also considers the implications for DC plans as the same essential arguments apply to all long-term savings pools regardless of their precise nature. It concludes that a DC, age-based default solution can accommodate the needs of many participants with different wealth levels. [ABSTRACT FROM AUTHOR