Reading 26: Linking Pension Liabilities to Assets－LOS c

The liability-mimicking, low-risk portfolio will be costly. The future liability from future service rendered and future participants is uncertain and is not funded. An investment in the liability-mimicking portfolio would therefore require future cash payments by the sponsor to satisfy these obligations. By construction, the liability-mimicking portfolio will not provide a return in excess of the liabilities. For pension plans, the best use of the liability-mimicking portfolio would be as a benchmark.

In the traditional asset-only approach, the portfolio is usually composed of 60%-70% equities with the rest in short and medium duration nominal bonds.

If the workforce is younger, more will be allocated to equities. If there were more inflation indexing, inflation-indexed bonds would be emphasized. If there were less inflation indexing, nominal bonds would be emphasized. If the plan was frozen, there would be no future obligations and nominal bonds would dominate the portfolio.