For the worst-funded, structural weaknesses rather than investment returns are now determining long-term outcomes. Investment returns can and should be improved, but the ultimate solutions may need to come from legislators.
Better-funded plans can still realize a decisive benefit from optimizing their asset portfolios. A decade of high market returns have left us with stretched valuations across traditional asset classes. We believe it is a critical time to rethink asset allocations in an effort to both realize gains of recent years and enhance return profiles given the growth rate of liabilities.
In this paper, we focus on the potential benefits of adding alternative investments to a multiemployer pension plan. We show their potential to move the long-term funding needle meaningfully in the right direction—even with lower asset class return outlooks for the coming decade.
Executive Summary
- We add the following alternative investments as options for “red-zone”, “yellow-zone” and “green-zone” U.S. multiemployer
pension plans:
- Private Equity
- Hedge Funds
- Private Real Estate
- PutWrite
- Real Assets
- We optimize portfolios with and without alternative investments (as defined above) across a range of asset volatilities and surplus volatilities, and show that adding alternatives improves the return profiles at each level of volatility.
- Using a long-term return assumption on assets of 6% as the liability discount rate, we find that adding alternatives to the asset portfolio of a “yellow-zone” plan that can tolerate a funded status volatility of 8% could double the probability of reaching 100% funded status within 15 years from 6% to 11%, relative to its pathway without alternative investments.
- A “green-zone” plan that can tolerate a funded status volatility of 10% could increase its probability of reaching 100% funded status within 15 years from 27% to 37%.
- Full results and methodology—including results obtained using a lower, FTSE Pension Curve-derived liability discount rate—are presented in appendices.
