Reading 17 - Example 6 - Page 282

CFA Level III Portfolio Management
#1

Anyone can give more details about what the below 2 sentences mean please ?

"The observed relationship that the allocation to corporate bonds declines with increasing surplus return can be explained by the positive correlation of bond price with the present value of liabilities.

The hedging asset (corporate bonds) is employed to a greater degree at the low end of the surplus efficient frontier"

Thank you,

BearFlag

#2

N.B.: I am assuming the above statements apply to a pension plan.

Pension liabilities behave very much like long-term bonds, so corporate bonds are a good hedging asset. If the funding ratio is 100% (or worse, lower), a higher allocation to corporate bonds is a conservative strategy. As the funding ratio exceeds 100%, then the surplus can be invested in riskier assets, i.e. invest outside of corporate bonds.