Asset Allocation for DB Plan, based on components of plan liabilities

CFA Level III Portfolio Management
#1

I have seen 2 AM questions on this: CFA 2012 AM #6(e) and Kaplan Schweser Exam 6 AM #8(a) and (b). I don’t see this material covered in the Schweser books though.

It looks like there are typically 5 DB Plan liability components given:

  • Current retirees

  • Deferred retirees

  • Active accrued

  • Future wage inflation

  • Future wage growth

The available asset classes are Equity, Real Rate Bonds, Nominal Bonds.

It appears to me that:

  1. For current retirees, deferred retirees, and active accrued, use 100% nominal bonds if payouts are not inflation-indexed. Use 100% real rate bonds if payouts are inflation-indexed.

  2. For future wage inflation, use 100% real rate bonds by default. If the case tells you the correlation with CPI, then use that as the % of real rate bonds and use nominal bonds for the rest. For instance, on Schweser Exam 6, #8, the case says future wage inflation is 60% correlated with CPI. The answer says to therefore use 60% real rate bonds, 40% nominal bonds.

  3. For future wage growth, use 100% equities by default. If the case gives you the correlation with equities, then use that as the % of equities, and use nominal bonds for the rest. On the Schweser question, the case says future wage growth is 75% correlated with equities. The answer says to use 75% equities, 25% nominal bonds.

Is this the correct thinking?

#2

For 2012 AM Question 6 - D and E are not relevant according to IFT

#3

Yeah, but it is included in the current Schweser Mocks. I think your summary meets it well, checked with the Schweser answer and this is how I would approach this. My mistake when doing the mock was getting the deferred retirees and active accrued right.

Once you know how to do it, it is no rocket science

#4

by deferred retierees, you mean people who took early retirement but are still not eligible for pension, right?