LDI in 2025: Ten questions corporate plan sponsors are asking

We often get great questions in our conversations with US corporate defined benefit (DB) plan sponsors and their consultants. To help prepare for the coming year, we offer our thoughts on some of the most common investing, funding, and accounting questions we’re hearing today.

Funded status has improved. Should plans be derisking? 

The aggregate funded ratio for US plans was 105% as of 20 December 2024, up from 97% at year-end 2023 as rates, while volatile, ended the year higher and equity returns were strong.¹ We think plans may want to consider locking in and protecting some of the year’s gains. Further, as noted in the question below, our forward-looking capital market assumptions indicate only a modest equity premium relative to long bonds. We suggest running a funded-ratio estimate, comparing it to the plan’s glidepath triggers (formal or informal), and evaluating whether and how to derisk. Potential derisking opportunities include:

• Credit (long or intermediate) — The focus here is on matching spread exposure in the liability. We think fundamentals and technicals, driven by demand for attractive all-in yields, are solid, and therefore spreads may stay tight and range-bound for longer despite relatively high valuations. Find our recent credit market views here and here. 
• Treasuries and STRIPS — Plans concerned about credit valuations can use Treasuries and STRIPS to derisk and leg into credit more opportunistically over time as spreads widen. Treasuries and STRIPS may also help plans manage to hedge-ratio targets and maintain a healthy liquidity buffer for benefit payments, rebalancing, and capital call needs. We think plans should consider researching credit managers and adding them to the “bench” to be ready to deploy capital when moving from Treasuries to credit. 
• Liquid infrastructure — This asset class could help plans derisk via exposure to companies that may have steadier, more bond-like cash flows, while also investing in potential growth themes, such as AI-driven demand for data centers and power generation.
• Defensive equities — This may appeal to plans that want to reduce risk but have higher return objectives or are looking to diversify their return-seeking allocations. In addition, we think valuations are attractive. (Read our article on defensive equities.)

ROAs rose in 2023. Where will they and capital market assumptions go next?

Corporate plans’ return on asset (ROA) assumptions, which had trended down for 15 years, increased by about 70 bps in 2023.² Our capital market assumptions as of late 2024 indicate lower forward equity returns, reflecting higher valuations and suggesting that some plan sponsors may reverse course and lower their 2025 reported ROA assumptions. More broadly, however, our 10-year expected return on equities is only modestly higher than that for long bonds, indicating that plans may not be rewarded for taking liability-relative risk.

More thoughts on ROAs and our capital market assumptions are in our paper: Setting ROAs for 2025: A guide for US corporate and public plans. 

Should plans pass on pension risk transfers?

We are often asked whether a pension risk transfer (PRT) is the right choice for fully funded plans. We are not unbiased observers and the decision will ultimately depend on each plan’s circumstances, but in many cases, we believe the downside risk reduction does not justify the costs or the lost upside optionality on pension surplus. And when it comes to managing downside risk, we think plan sponsors today have access to more sophisticated investment and plan design strategies than ever before. Read more in our recent article: Why more corporate plans should pass on pension risk transfers.

Is the pressure easing on potential contributions under PPA minimum funding rules? 

On the funding front, some good news for plan sponsors is that PPA funded ratios appear to be on the rise thanks to strong year-to-date asset performance and a modest uplift in the liability discount rate. The combination of these factors put the estimated average PPA funded ratio at 105% to 110% as of mid-December, a far cry from funded levels of nearly 140% in early 2022 but an improvement versus about 100% at the beginning of 2024.

The risk case for future contributions is another 2022-like environment, where bond returns are sharply negative but the liability discount rate is constrained from rising due to the PPA interest-rate stabilization provisions, limiting the decline in the liability. We think cash-sensitive plan sponsors should continue to monitor the interest-rate environment, including using scenario analysis to quantify funding requirements under different market and interest-rate scenarios, so that they are not surprised by annual funding valuations. As we’ve noted previously, some plan sponsors with large liability-hedging allocations or high liability-hedge ratios are also considering electing the PPA “full yield curve,” which is close to a market discount curve and could help eliminate the mismatch between bond returns and the PPA liability experience (sponsors should consult with their actuary and/or legal counsel to understand the full set of implications for this election).

What do plans need to know about intermediate credit and how should they decide on allocation sizing between intermediate and long-duration credit? 

Intermediate credit remains an area of interest, particularly among plans that are better funded and no longer need capital-efficient sources of duration and spread duration. Here we offer a few thoughts on the differences between long and intermediate credit: 

• Liquidity: The intermediate segment of the market is significantly larger and more liquid than the long end. 
• Sector composition: Intermediate indices have much larger allocations to the financial sector than long indices. Plans might want to establish benchmark-relative industry limits across intermediate and long-duration portfolios, as opposed to absolute limits. The latter can be more restrictive in an intermediate portfolio given the concentrated nature of the market in certain industries, which can limit a manager’s ability to express active views.
• Credit spread duration and style diversification: While the differences in duration and credit spread duration between intermediate and long credit are obvious, it’s worth bearing in mind that those differences may add style diversification to the liability-hedging portfolio. 

Read more on the potential benefits of widening the investment-grade opportunity set with intermediate credit here.

In terms of the sizing decision, the appropriate long versus intermediate split will be affected by a plan’s liability duration, return-seeking assets, and other variables. Understanding the sizing effect on funded-ratio volatility can help quantify the decision. For more detail on sizing, including examples, please see our paper: Extra credit for corporate plans: Advanced topics in LDI implementation

Should plans consider investment-grade private placements as a liability-hedging diversifier? 

Some plan sponsors have started to consider investment-grade private placements in the liability-hedging allocation, following in the footsteps of life insurers, who allocated about 44% of their bond portfolios to this asset class as of year-end 2023 (most recent data available).  Why? Private placements offer the potential for:

• Incremental yield — The premium over public investment-grade credit can differ greatly deal by deal, but it has historically tended to be at least 50 bps for syndicated deals and can potentially be higher for club and directly sourced deals. More recently, the premium increased to about 72 bps in 2024, as higher all-in public investment-grade yields provided more competition from yield-based investors. 
• Diversification — Issuers include not just industrials, utilities, and financials but also non-corporates such as sports teams, higher education institutions, health care organizations, and municipal or sovereign credit exposures. A wide range of maturities are also available. 
• Downside mitigation — Credit-protective covenants and prepayment provisions offered by private placements may play a role in mitigating downside risk. 

The illiquidity premium, or potential incremental yield, from private placements may also help mitigate a portion of the “downgrade drag” plan sponsors face when investing in a duration-matched hedging portfolio — and without introducing more than nominal projected tracking risk to the liability. This drag exists because downgraded bonds are typically negative for index returns but have no bearing on the liability. More detail is available in our article: Private placements: A primer for corporate DB plans preparing to derisk.

Why should plans consider diversifying a return-seeking allocation?  

With US equity returns so strong over the last few years, some allocators have wondered whether the rule of thumb that “investment diversification adds value” still holds — and whether it should still be applied to a return-seeking allocation. Wellington’s Head of Multi-Asset Strategy, Adam Berger, offers thoughts on navigating questions about this and other rules of thumb in his recent article: A guide to investing in the age of anxiety.

In an LDI context, we continue to think liability-aware diversifiers offer the potential to reduce funded-ratio volatility while retaining some upside to funded-ratio return. Examples include infrastructure, real estate, net long or market neutral hedge funds, and return-seeking fixed income. While plans may look to implement some of these diversifiers in private markets, public implementation — stand-alone or as a complement to private exposure — also may be worth consideration, especially in light of the “denominator effect” many experienced coming out of 2022 (further thoughts on illiquid allocations below). 

We would also note that while 2023 and 2024 were challenging for several of these return-seeking diversifiers relative to US large-cap equities, this could represent an attractive opportunity to add to or initiate strategic allocations — especially as our 10-year capital market assumption for US large-cap equities has moved from 6.5% as of 31 December 2022 to 4.1% as of 30 September 2024.

Another hot topic related to return-seeking portfolios is benchmark concentration and narrow market performance. There are a few potential levers for managing market narrowness, including extension strategies (e.g., 140/40 strategies) and index completion sleeves. This topic is explored by our Fundamental Factor Team in this new paper: Concentrated markets: Implications for active management, manager research, and multi-manager capital allocation. 

How should plans think about illiquidity risk and managing liquidity? 

Managing liquidity continues to be top of mind. Concerns can arise from synthetic interest-rate hedging overlays (or equity overlays) that may require large margin posting, illiquid/private asset exposure, unpredictable lump-sum benefit cash flows, and/or potential risk-transfer activity.

We think these analytical techniques could help with an assessment of liquidity needs:

• Stress-testing environments where liquidity may be challenged — For example, plans that have both interest-rate overlays and private exposure might want to test a scenario of rising rates, negative equity returns, and increased capital calls. (See our paper for examples.) 
• Liquidity bucketing — Many plans have bifurcated liquidity needs, requiring liquidity to meet substantial near-term benefit payments (it’s not unusual for a plan to defease 15% – 20% of its liability over the next three years) but also being able to be a liquidity provider for cash flows that stretch out over decades. Even for a mature plan liability, a substantial portion of cash flows may not come due until more than 10 years in the future, which may allow for some illiquidity risk to be taken in private market assets. (Plans also should consider other drains on liquidity, as noted in the above bullet on stress testing.) At the same time, there are also liquid complements to asset classes like private credit, real estate, and infrastructure that can be paired with private allocations. 

How should a plan decide between hedging its surplus and hedging its funded ratio? 

As more plans become overfunded and move toward an end-state, this question has come up with greater frequency. When it comes to hedging against interest-rate risk, plans need to decide whether the focus should be on immunizing the plan’s dollar surplus or its funded ratio from rate changes. In an ideal world, the answer would be “both,” but mathematically, it’s not possible to fully hedge both the surplus and the funded ratio unless a plan is exactly 100% funded.

Plans can run simulations to quantify the trade-offs of prioritizing one objective over the other and consider these in the context of the overall philosophy and objectives. For examples, see our paper: Extra credit for corporate plans: Advanced topics in LDI implementation.

What is the credit risk contribution from equities and how does it impact the credit-sizing decision? 

It’s generally understood that a plan’s hedging allocation should hold less credit/more Treasuries when the plan still has a large return-seeking/equity allocation (given the historical and expected positive correlation between equities and credit excess returns) and more credit as it approaches its end-state (when the return-seeking allocation is typically smaller). But how does this translate into a specific allocation between credit and Treasuries in the hedging portfolio?

Based on our research and historical analysis, 5 – 6 years of high-yield credit spread duration may be a good rule of thumb for developed market equities for those looking to directly assign a credit hedge ratio to equities. Alternatively, plans can seek to optimize the allocation using mean-variance analysis. We’ve found the two methods produce generally consistent asset allocation recommendations. For more in-depth analysis on estimating the credit risk from equities and incorporating it into an asset allocation, please see: Extra credit for corporate plans: Advanced topics in LDI implementation.

¹Based on estimated changes in yields and asset returns since reported funded ratios and discount rates at year-end 2023. Year-end data based on year-end 10-K filings of Russell 3000 companies in each given year with a December fiscal year end. 2024 estimate based on funded-ratio and discount rates estimated by Wellington Management based on change in high-quality corporate bond yields (Bloomberg US Long Credit Aa) since 31 December 2023 and performance of equities (MSCI World), bonds (blend of Bloomberg US Long Government/Credit and Bloomberg US Aggregate), other investments (blend of HFRI Fund Weighted Composite Index, MSCI All Country World, and Russell 2000), and real estate (NCREIF Property Index). Actual results may differ significantly from estimates. Results presented at the aggregate Russell 3000 Index level. Sources: FactSet, Wellington Management. | ²Sources: FactSet, Wellington Management. Based on year-end 10-K filings of companies in the Russell 3000 Index in each given year. For illustrative purposes only.

Not actuarial or legal advice. Refer to actuary and counsel for advice specific to your plan. 

Important disclosures: Capital market assumptions

Intermediate capital market assumptions reflect a long-term time period of approximately 10 years. If we developed expectations for different time periods, results shown would differ, perhaps significantly. Additionally, assumed annualized performance and results shown do not represent assumed performance for shorter periods (such as the one-year period) within the 10-year period, nor do they reflect our views of what we think may happen in other time periods besides the 10-year period. The annualized return represents our cumulative 10-year performance expectations annualized. The assumed returns shown do not reflect the potential for fluctuations and periods of negative performance.

This analysis is provided for illustrative purposes only. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares, strategies, or other securities. References to future returns are not promises or even estimates of actual returns a client may achieve. This material relies on assumptions that are based on historical performance and our expectations of the future. These return assumptions are forward-looking, hypothetical, and are not representative of any actual portfolio, or the results that an actual portfolio may achieve. Note that asset-class assumptions are market or beta only (i.e., they ignore the impact of active management, transaction costs, management fees, etc.).

The expectations of future outcomes are based on subjective inputs (i.e., strategist/analyst judgment) and are subject to change without notice. As such, this analysis is subject to numerous limitations and biases and the use of alternative assumptions would yield different results. Expected return estimates are subject to uncertainty and error. Future occurrences and results will differ, perhaps significantly, from those reflected in the assumptions. ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY AND AN INVESTMENT CAN LOSE VALUE. Indices are unmanaged and used for illustrative purposes only. Investments cannot be made directly into an index.

This illustration does not consider transaction costs, management fees, or other expenses. It also does not consider liquidity (unless otherwise stated), or the impact associated with actual trading. These elements, among others, associated with actual investing would impact the assumed returns and risks, and results would likely be lower (returns) and higher (risk).