DOL Provides Comfort on Liability-Driven Investment Strategies
If you forgo the higher potential returns on equities and invest your ERISA plan clients in fixed income and other conservative investments, so as to best ensure that the plan has money available to fund expected distributions down the line, are you doing something wrong?
No. DOLís Employee Benefits Security Administration recently issued an advisory opinion that confirms that a plan fiduciary may "risk manage" assets in a defined benefit plan by investing with an eye towards upcoming funding liabilities. The issue arises in the context of "liability-driven investment" strategies, which seek to match assets with liabilities so as to reduce volatility in funding levels, therefore limiting the risk that a plan will be underfunded. An LDI strategy, however, may incidentally benefit the plan sponsor by reducing volatility on the sponsorís financial statements.
In the opinion, Advisory Opinion 06-08A, DOL provided comfort that such investment strategies are not problematic: "[T]he Department does not believe that there is anything in the statute or the regulations that would limit a plan fiduciaryís ability to take into account the risks associated with benefit liabilities or how those risks relate to the portfolio management in designing an investment strategy," it said. A plan fiduciary would not run afoul of ERISAís exclusive benefit, prudence, or diversification requirements "solely because the fiduciary implements an investment strategy for a plan that takes into account the liability obligations of the plan and the risks associated with such liabilities and results in reduced volatility in the planís funding requirements," said the opinion.
Groom Law Group partner Rick Matta described the opinion as both "expected and significant." LDI strategies, he noted, became popular after the last market downturn, when some plans lost 20 or 25 percent of their value. However, he added, the strategies have raised a number of concerns. "Plan sponsors and other fiduciaries have been concerned that if they look at their contribution volatility and their willingness and ability to fund the plan in making investment decisions for the plan, that they would somehow be looked at as self-dealing," he explained.
Moreover, LDI strategies raise concerns about diversification, with some questioning whether a plan that is heavily invested in fixed-income and low-risk investments is properly diversified. Moreover, Matta pointed to a somewhat amorphous concern that under modern portfolio theory, it is "simply somehow more prudent to invest in equities" because they traditionally produce higher returns. "These concerns have been lingering out there for a long time," he said. By confirming that LDI strategies are appropriate, he said, the opinion "endorses what everybody was thinking all along."