liability mimicking or asset only approach?

CFA Level III Portfolio Management
#1

The question is that the DB plan is in deficit. The sponsoring company wants to eliminate the funding shortfall without additional contributions to the plan. Should it use liability mimicking or asset only investment approach?

My answer is:

The cash flow from investment assets mimick the liabilities stream. Use derivatives to hedge the market related exposures of the liability mimicking assets. It is more efficient and free up funds. The remaining funds can be used to invest in high risk high return generation. The funds invested in this way allows pension fund to match liability stream and generate returns in excess of pension liabilities. Therefore, liability mimicking could achieve the objective.

The CFA answer is: Liability mimicking could _ not _ achieve the objective. When the cash flows of the assets mimic the cash flows of the liability stream, the liabilities are essentially immunized. Immunization should prevent the pension shortfall from worsening. However, immunization also means that the return on the assets will not exceed the implicit return on the liabilities, and will thus be insufficient to eliminate the underfunding of the pension plan.

Is the asset only approach really better to overcome funding shortfall?

#2

what you described is already asset only, as soon as you started talking about trying to invest actively to earn a little extra something something. you are no longer just mimicking liabilities, you’re trying to close the gap using asset only investment approach. CFAI outlines that pretty clearly and you paragraph pretty much went against every point it made on why liability mimicking doesn’t work.

#3

thank you. i confused myself with the approaches.