Corporate Pension Investing: The Bear Necessities

While some sponsors are treating 1Q’s equity slump as a risk-on opportunity, there have also been a number of bears emerging from hibernation. And not unreasonably so—the market is pricing in an economic slowdown, GDPNow is forecasting a contraction, pundits are discussing stagflation, and even major investment banks are talking about a 20-40% chance of recession. 

Spread markets are also reflecting a higher probability of a slowdown, with the ICE BofA U.S. High Yield Index Option-Adjusted Spread (OAS) increasing to 322 basis points (bp) as of March 11, 2025, up from 266 bp on December 31, 2024. 

This 56 bp widening over the past two and a half months is a clear sign that investors are getting more cautious. So what’s a concerned sponsor to do? The simple answer for those with an LDI program in place is to let that program do its job. Since LDI emerged as a strategy from the ashes of the tech bubble and the global financial crisis (GFC), it’s been nothing short of amazing to see how a solid LDI solution can weather any storm, from the pandemic to the inflation and interest rate shocks of 2022. 

Even if there is no LDI program in place, it’s always a good time to mitigate risk. Here’s how to do that without sacrificing return.

While higher yields have been a boon to fixed income returns recently, they won’t last forever. And the double whammy of declining rates plus a drawdown in equities can be disastrous for plans’ funded positions. The last two times this happened—the tech bubble’s burst and the GFC—pension plans experienced an average decline in funded ratios of over 30 percentage points. 

More recently, the 2013 “taper tantrum” helped cause a spike in average funded status from 76% to 88% in a single year. However, despite significant accelerated contributions ahead of the Tax Cuts and Jobs Act (TCJA) of 2017, average funded status remained stubbornly at 81% from 2014 through 2017. It was only when plans started shifting out of growth-seeking assets and into fixed income in 2019 that we saw improvement in and preservation of funded status before rates rose significantly in 2022 (Exhibit 2). 

The key to reducing funded status volatility is shifting  allocations from equities to duration-matched fixed income. The greater the duration-matched fixed income allocation, the more resilient the funded status. For example, a 20% allocation shift from equities to fixed income could save 3% to 4% of funded status percentage (see Plan 2 versus Plan 3 in Exhibit 1).

The risk and reward tradeoffs in pension investing are asymmetric. An overfunded position can lead to burdensome excise taxes for a full plan termination, while an underfunded position can reignite variable Pension Benefit Guaranty Corporation premiums and required contributions. Increased volatility in funded status is not something anyone wants to deal with right now, especially since convexity in the liability means that falling interest rates increase liabilities more than rising rates decrease them. 

In these times of uncertainty, securing the plan’s funded position is paramount. The way to do it is via a robust fixed income allocation that fully hedges the liability and is well diversified to mitigate concentration risk, downgrades, and defaults.

Current yield levels are a feast for fixed income investors. Higher-yielding fixed income investments have recently been on par with the expected returns of most equities, while carrying a reduced risk profile. They also serve to reduce surplus volatility, with duration that can mirror that of the liability. Sponsors have the opportunity to lock in these yield levels—which haven’t been accessible at any level of risk since 2007—but will likely have to act quickly. 

Every pension plan is unique, but locking in current yields offers benefits regardless of the plan’s specific needs. For open and accruing plans, longer-duration investments can be advantageous, while frozen plans may benefit from intermediate-duration assets. 

At these yield levels, sponsors can achieve a de-risked asset portfolio without compromising the expected return on assets (EROA) assumption, effectively offsetting pension costs. It’s like having your picnic and eating it too—enjoying the high yields while mitigating volatility.

In the past, large fixed income allocations meant large investment grade corporate bond positions. That’s not optimal for a number of reasons, including concentration risk, which can lead to overexposure to credit events such as downgrades and defaults. The simple fact is that better spreads with lower historical defaults are available elsewhere. 

The modern pension toolkit includes:

• Investment grade private placements: Private placements can offer issuer diversification and structural enhancements to mitigate credit events. In addition, there are a variety of issuers that span corporate, asset-based finance (ABF), and infrastructure, to help diversify the underlying credit exposure. On average, investment grade private placements have historically offered a 79 bp spread premium to equivalent corporate bonds.
• Commercial mortgage loans (CML): Long a favorite of insurance companies, CMLs offer stable cash flows and diversification benefits, especially when focused on retail, industrial, and multi-family properties in high-growth secondary markets.
• Securitized credit: Securitized credit can help hedge duration and spread risk while offering additional benefits such as higher spreads, structural enhancement, and diverse underlying credit exposure. Together, these solutions have been vetted, tested, and successfully implemented across more than a dozen blue-chip corporate pension plans, totaling over $6 billion in liabilities. They are key elements of the defensive investing toolkit in 2025, allowing fixed income diversification while also potentially enhancing returns and reducing tracking error.¹

To further protect against unexpected rate movements, consider using Treasury futures, interest rate swaps, swaptions, and other hedging tools. These derivatives can help insulate the portfolio against adverse rate movements, allowing the plan to maintain stability regardless of market shifts. 

Derivative hedging strategies are especially useful for underfunded plans that do not have enough physical fixed income assets to duration-match the liability cash flows. Diversification is key, and derivatives can be a powerful tool in the bear’s risk mitigation toolkit.

Market leaders like Voya offer a wide array of highly innovative, tailored LDI solutions for plan sponsors. These solutions range from more efficient long government/credit strategies (blending investment grade private placements with public corporate bonds) to more tailored solutions inspired by insurance company best practices in managing reserves for annuities. 

In a market characterized by uncertainty and potential economic slowdown, a well-crafted LDI strategy is more crucial than ever. By securing the plan’s funded position, locking in current yield levels, and leveraging advanced LDI solutions to diversify, enhance, and hedge, plan sponsors can navigate the complexities of the current economic climate with confidence. 

The resilience of a solid LDI program is a testament to its effectiveness, and it remains a cornerstone of corporate pension investing. Just like a bear in its den, a well-protected pension plan can weather any storm.

A note about risk 

Please note that liability valuations can increase due to falling interest rates or credit spreads, among other things, as the present value of future obligations increases with falling rates and falling spreads. Liabilities can also increase due to actual demographic experience differing from expected future experience assumed by the plan’s actuary. Please keep in mind that diversification or broad asset allocation, in and of itself, neither ensures nor guarantees better absolute performance or relative performance versus the pension plan’s liabilities. In addition, investing in alternative investment products (e.g., derivatives) can increase the risk and volatility in an investment portfolio. Since investing involves risk to principal, positive results and the achievement of an investor’s goals are not guaranteed.