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Up7
In the portion of this chapter dedicated to Defined Benefit Pension Plans, they analyze asset allocations from the perspective of PV of contributions and the 95th percentile of PV of contributions (see attached chart). I’ve read that thing several times and I still don’t understand how the efficient frontiers are built and how the asset allocations influences the PV of expected contributions (or vice-versa).
Anybody with a clear insight on that?
Many thanks in advance.
Vincent
Efficient Frontiers DB Pension Plan.png
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Up3
If it is DB pensions, the ‘risk’ aspect is to minimize the downside of needing to top-up the fund with cash contributions, if the assets of the fund is lower than the future defined obligations (liability).
The DB pension fund sponsors want to maximize returns (to improve and maintain a surplus status), but also have downside protection and reduce the volatility of that funded status. One of the ways they do the latter is by matching the liability risk with longer duration bonds, i.e. Portfolio D, which shows a shift to the left. Ideally they want low risk, high return portfolio mix, i.e. top left of the chart if feasible, but there is a trade off.
I would imagine they use monte carlo simulations with various market assumptions to run complicated scenario modellings for this and build this efficient frontier.
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