Asset Allocation for “End-State” Portfolios

Abstract

In recent years many US corporate pension plans have closed and entered their “end-state.” As end-state plans have become more prevalent, their special portfolio management challenges, including asset allocation, have gained attention. Pure immunization with public fixed income assets (“hibernation”) is a possible investment management strategy to try to minimize funding ratio variability. But this may not be sufficient for all end-state plans. For example, mortality risk could cause the actual cash liabilities to deviate from the estimated cash liabilities. This risk may argue for the inclusion of return-seeking assets. In addition, some plans have had good performance experience with their illiquid private assets (e.g., private real estate, private equity, and private credit funds). How can a CIO evaluate the potential of these private assets remaining in their end-state portfolio? We use our asset allocation framework (OASIS™) to help end-state investors solve for optimal asset allocations. An asset allocation solution seeks to maximize the end-state portfolio’s expected horizon value while meeting future cash obligations at a desired confidence level and keeping the funded status at a target level of stability over the investment horizon. We show that private assets can play an important role in helping end-state portfolios achieve their return objectives while meeting their liquidity and funded status stability constraints. CIOs managing end-state portfolios may impose additional constraints to address their specific concerns. For example, CIOs may impose an upper limit on their total allocation to private assets, impose a floor on the plan’s funding ratio, or express views on expected private asset performance and their fund-selection skills. Making asset allocation constraints more restrictive typically implies a less risky portfolio, with a lower allocation to private assets. The OASIS framework helps CIOs measure this tradeoff between performance and their constraints, allowing them to make better business decisions.