With annuities largely comprised of fixed-income investments, can the sponsors of pension plans gain an advantage by replicating such a portfolio on their own with a focus on private debt?
During a presentation for plan sponsors in Toronto on Thursday, Michael Augustine, a managing director at TD Asset Management Inc., touted the option of reducing pension risk without necessarily buying an annuity. While pension plan solvency levels have been healthy in recent months, shifts in credit spreads and factors such as increased longevity could chip away at their funded status, he noted. And with investors searching for higher yields, reduced barriers to accessing areas like private debt are opening up new opportunities for plan sponsors to improve their positions, according to Augustine.
Instead of buying an annuity, Augustine presented a portfolio comprised of 50 per cent investment-grade private debt, with the remainder allocated to public fixed-income investments (a mix of corporate and provincial bonds). “We refer to this as the do-it-yourself annuity portfolio,” Augustine told attendees at an investment event hosted by TD Asset Management at the Toronto Board of Trade.
Augustine took the audience through the scenario of buying an annuity for $100 million. Buying an annuity carries an implied cost of $10 million versus purchasing the underlying assets instead, he noted. That’s because, based on market assumptions as of Dec. 31, 2017, an investor would have seen a 93-basis-point advantage from the underlying assets versus the rate earned on an annuity.
While Augustine emphasized he wasn’t suggesting pension plans should actually adopt such a portfolio, he said they could embed the approach into their assets in a similar fashion to a buy-in annuity. Options, he said, include “demographic-driven investing” in which a plan sponsor applies the approach to certain members, such as retirees, and taking the idea even further through an equity overlay. In that case, an investor retains a small allocation to equities in order to use the gains tactically to top up the do-it-yourself annuity portfolio. The approach is an option, Augustine noted, for pension plans that still need to reach full funded status.
Augustine also acknowledged the upsides and downsides of the various options, whether a plan sponsor chooses to actually buy an annuity or embark on the do-it-yourself route. “It’s a one-way street,” he said, referring to the annuity option. On the other hand, the do-it-yourself option doesn’t eliminate the longevity risks plan sponsors face, and it still involves ongoing administration of the pension plan.
As for investors’ questions about private debt, Augustine acknowledged the heightened need to do the credit research. “We’ve been focused on investment-grade private debt,” he said, noting that with estimates pegging the size of the private debt market in North America at about $100 billion, investors considering the option would likely need to look internationally for investment opportunities.