I know what you’re thinking. First Kenny Rogers and now the Rolling Stones? Why does this guy keep quoting 1980s songs and relating them to defined benefit (DB) plans?
Well, there were two things I did during my summer nights as a teenager growing up in the ’80s that left a lifelong impact on me – listening to music and dreaming about DB plans. Didn’t we all? More on this later….
Anyway, in my last post, I introduced the idea of dynamic asset allocation (DAA) as a DB plan risk management strategy. This strategy works particularly well with hard frozen DB plans.
What is DAA?
DAA is an investment strategy that adjusts the asset allocation of a DB plan. The adjustments are made based on changes to a plan’s funded status (the ratio of plan assets to termination liabilities).
Because of concerns plan sponsors may have in adopting a liability-driven investing (LDI) strategy, using DAA helps transition to LDI over time.
Asset allocation is driven by a predetermined “glide path.” This glide path changes the investment mix based on the plan’s funding status. As the funded status improves (or as interest rates increase), this strategy shifts plan funds from equities into longer-duration fixed income investments.
Going forward, the DB plan actuary and investment advisor work closely together to execute this strategy.
Take the emotion out of investment decisions
Many DB plan sponsors are interested in risk management techniques like LDI.
But one of the more difficult challenges they face when moving away from a total return investment approach is often knowing when to “pull the trigger” on investment changes. Developing a pre-determined, formal DAA strategy can help take the emotion out of these decisions—helping to come to DB plan sponsors’ emotional rescue.
In addition to blogging here, I also tweet regularly about DB topics of interest. Click to follow me on Twitter- @scottruba.
Insurance products and plan administrative services are provided by Principal Life Insurance Company. Securities are offered through Princor Financial Services Corporation, 1-800-547-7754, member SIPC and/or independent broker dealers. Securities sold by a Princor® Registered Representative are offered through Princor. Princor and Principal Life are members of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.