One way I am using to cover this topic is to prepare some kind of IPS format…I Hope this works for you…It was done based o CFA Notes and Schweser notes IPS FOR A DEFINED BENEFIT PENSION PLAN 1. Return Objective: a. Return objective is to achieve a total return sufficient to cover pension liabilities in an inflation-adjusted base. The plan has a total return objective is X%, Y% higher than the actuarial required return b. Given it overfunded status, the long duration, sponsor financial strength, the fund should be managed with a long-term growth orientation with a focus on capital appreciation. If there are high liquidity needs and older workers an income approach focus should be recommended c. Also it could be mention that the plan should try to achieve a return over the assets benchmarks forming the portfolio d. If the fund is underfunded or Risk tolerance is low given financial sponsor situation or participants age, not take an aggressive investment approach and indicate that the sponsor should increase contributions 2. Risk Tolerance: a. The fund Risk tolerance is high because, larger plan surplus, low firm debt to equity, high current and expected firm profitability, Young average age or greater active lives related to retired lives, is a long term going concern plan, there is a low correlation between the firm’s assets and pension assets, and there are not or little provisions for early retirement and lump-sum distributions (reduces time horizon and increase liquidity requirements) 3. Constrains: i. Liquidity: Given the low proportion of retires respect to actives, higher sponsor contributions over payments, the high profitability of the funds (less contributions), no early retirement provisions, the liquidity requirements are considered low ii. Horizon: 1. Given the young average work force (35-50), the going concern definition of the plan (not a terminated plan) the plan horizon is long term 2. Alternative, given the high average work force (55) and the going concern definition of the plan, the plan horizon is long term but also focused on addressing the short term needs iii. Taxes: The plan is tax exempt iv. Legal and regulatory: The plan must be managed according the local Regulations. ERISA requires due diligence in investment decisions and manage the fund in the best interest of the participants, not the sponsor v. Unique Circumstances: The board has determined self-imposed restrictions to the X class of investment acting in a socially responsible investing way. Also, given the small size of the sponsor, not resources and expertise are available to comply with due diligence required by ERISA, then alternative investments are not considered
thanks, it’s a good summary
I think the risk tolerance has to be connected to the overfunded/underfunded status and the average age (or average time to retirement). If the plan is underfunded, the risk tolerance is fairly low. The difference between PV(assets) and PV(liabilities) is what really determines ability to take risk. Remember that willingness to take risk can be stated in the problem. Given the ability to take risk and the willingness to take risk, the answer is always the lesser of the two, although in the case of high ability/low willingness, you can counsel the clients that they can really afford to take more than they are taking and see if they are comfortable with that. Liquidity needs can also vary with the plan. It looks like you prepared this outline from a specific problem. That’s fine, and your answer is probably correct - but this template isn’t quite suitable as a “generic solution to all DB plans.” If few retirees and lots of actives, then liquidity needs are fairly low (usually you’d measure this by expected payments in the short term as a proportion of total assets, and make some judgement). Hope this helps… it looks like you’re more or less on the right track!