Liability Relative approach

CFA Level III Portfolio Management
#1

Sch book 2, LOS 16c, Pg 56, para 2

It says ‘the liability mimicking, low risk portfolio, however, will be costly and, by construction, will not provide a return (i.e., accrual value) in excess of liabilities.’

Is there any hidden message, which I am not able to catch?

I thought any strategy could also fall short of the requirement as per liabilities. The above statement focuses on excess and not on short.

Thank you

#2

when u do not get a return in excess of what the liabs need you will fall short of the liabs - so u will not be in excess - ur pension is likely to have a shortfall

#3

Good,

Now then what could bea good reason y then the liability relative approach is being taken.

Instead a asset only absolute return approach could be opted.

Kindly let me know your view.

Thank you

#4

Asset only perspective -> 60-70% equities + remainder to short and intermediate duration nominal bonds.

liability relative -> longer duration nominal bonds + real bonds + equities + derivatives to hedge the liability and remainder in a return focused well diversified component.

— why may corps not implement the liability mimicking portfolio

  1. investing in the liability mimicking portfolio will not generate returns in excess of the liability.
  2. future service benefits and future participant benefits would be defeased therefore by future cash contributions
  3. this is a low risk strategy - but is too expensive to maintain in the long run. so this is normally used as a benchmark to measure investment risk, rather than invest in it.
#5

Bulls eye

#6

Per your answer, can I view liability mimicking same as liability relative? Thx

#7

think this way, liability mimicking portfolio is risk free investment in liability relative approach.

#8

Yes, it’s the same thing