In Asset Allocation curriculum:
“In underfunded plans, the potential upside of equities would often have greater value for the plan sponsor than in the fully funded case examined.” In Institutional Investors curriculum:
“Lower pension surplus or Lower funded status implies lower risk tolerance.”
In Asset Allocation curriculum, equity has greater value for underfunded plans. But in Institutional Investors curriculum, sponsor has lower risk tolerance which should allocate less equity for underfunded plans. Which is right?
So I think you’re missing the thin line in between. For a Pension plan that’s underfunded, if actually perfect decisions are made regarding investing in equities, there’s a good chance that the superior return would bring the funded status of the plan from underfunded to a possible surplus, given the high risk, high return nature of equities. It would be risky for me as a pension fund manager to allocate funds to equity, given the underfunded status but if I ace at it I can actually create value beyond dreams for the pension plan sponsor.
The Institutional side is saying that because the plan is underfunded, ideally you would not risk your money by investing in high risk assets and would prefer something low risk to bring the fund back to its fully funded status, as these are promised payments to your employees and wouldn’t wanna risk that money or I can risk being sued.
Hope this was helpful.
But if I add more low risk, low return security to portfolio, how can I bring the fund back to fully funded status?
You won’t get a surplus overnight. It would take a long time for you to get to a surplus with those low risk investments. The thing managers aim at is getting the plan to a fully funded status with low risk investments.