When corporate pension plan sponsors faced significant underfunding and long-duration liabilities, along with persistent low interest rates, after the global financial crisis, many pursued liability-driven-investment programs to address the critical problem.
Those risk management strategies worked. Now plan sponsors live in heady times, with the 100 largest corporate pension plans at 104.1% funded, according to Milliman. The average duration liability for corporate pension plans also fell to fewer than 10 years, and for many, portfolio hedges dwarf return-generating assets.
That has left many plan sponsors at a crossroads as they rethink hedging within their pension portfolios. NEPC’s annual Corporate Defined Benefit Peer Study and Survey, released in April, showed plans did not de-risk further in 2025, with the average fixed-income allocation across the consultancy’s peer group roughly unchanged year-over-year. Some plan sponsors are exploring nontraditional LDI diversifiers, such as private placements, structured products and real estate debt for hedging, with 37% of surveyed plans using at least one of these asset classes to hedge.
Given pension plans were significant buyers of long-duration U.S. Treasury and corporate bonds for traditional LDI programs, diversifying out of traditional hedges could affect both the bond market—if pension plans are no longer price-insensitive buyers of longer-dated bonds—and the role of fixed-income managers.
Impact on Bond Market
Pension liabilities have fallen for multiple reasons, including plans maturing, sponsors closing or freezing plans (which prevents new liabilities from accumulating), and higher interest rates mechanically shortening liability duration.
Jared Gross, head of institutional portfolio strategy at J.P. Morgan, says when durations were longer, some LDI models customized benchmarks to precisely match liabilities by using core holdings of traditional long-duration bonds, including Treasury STRIPS [Separate Trading of Registered Interest and Principal of Securities], other zero-coupon Treasury bonds and interest-rate derivatives.
With shorter durations, plan sponsors will need more intermediate-maturity credit and government bonds, and fewer from the long end of the yield curve, Gross says. Pension funds also are likely to buy fewer Treasury STRIPS or interest-rate hedges, although the need for longer-dated products will not completely end.
Gross says it’s possible that lower demand for long-dated Treasury bonds could impact the steepness of the Treasury yield curve, because fewer buyers for long bonds could force the yield on the bonds higher to attract investors. There is evidence pension-hedging activity causes some incremental value changes between traditional coupon Treasury bonds and STRIPS, but it tends to be very small, since the Treasury market is deep and liquid.
“Modest shifts in pension demand, while they might put a thumb on the scale in one direction or another, are generally not going to be the primary driver of where interest rates are,” Gross says. “[It] would be a surprise, I think, to see an outsized influence on Treasury” yields.
Liying Wang, associate professor in the department of finance at the University of Nebraska-Lincoln, expects more corporate-bond issuance will shift to the intermediate and shorter part of the yield curve if pension liabilities’ duration remains shorter. Academic evidence shows that when the Department of the Treasury changes its issuance pattern and volume, corporate borrowing tends to fill the gap to meet investor demand. That could have an impact on companies, Wang says.
“If they start to issue shorter-term maturities, it means that they need to come to the market more often, and also they may have higher rollover risk,” Wang says. “We would expect to see that firms refinance more often and more actively manage their debt maturity.”
Matt Maleri, head of insurance at NEPC, says some pension plans are selling their long-duration fixed-income holdings, something considered unlikely five or 10 years ago, and buying in the belly of the yield curve. But he hesitates to say pension funds will no longer buy longer-duration debt.
“There are still many plans that need to buy long-duration fixed income, and there will be many that continue to hold it, but certainly you’re seeing a more emphasis and a bigger shift toward intermediate duration,” Maleri says.
Changes to Portfolios Management
The higher funded status and reduced liabilities mean the hedging part of the portfolio does not have to work as hard to offset the liability risks, Gross says.
Plan sponsors can now look at portfolios holistically and seek opportunities to allocate across asset classes, reducing risk but preserving enough investment return to outperform a plan’s liabilities, what Gross refers to as “portfolio stabilization.”
Matt Clink, a senior partner in Aon, says in the past few years, Aon has revisited how it manages its LDI strategies, no longer viewing assets as either purely return-seeking or liability-hedging. As such, Aon is practicing “enhanced LDI,” Clink says, by including investment-grade private credit, private real estate debt and collateralized debt among hedging assets.
“This is one of those things where a little bit goes a long way … to diversify the portfolio,” Clink says, stressing that these are tradeable investments with monthly liquidity.
Aon uses these kinds of assets instead of investment-grade corporate bonds because they offer higher yields. Aon still manages the nontraditional assets as buy-and-hold investors until the plan may be ready to terminate. Exiting positions in assets such as private credit, private real estate debt and collateralized debt can take multiple quarters, he adds.
Maleri says NEPC is not sold on the idea that all the bond alternatives are perfect liability matches, but for plans with heavy fixed-income and hedging assets, exploring these alternatives as diversifiers makes sense.
What It Means for Managers
Maleri says NEPC is seeing many plans stick with their current investment managers, but change their mandates, such as moving into intermediate-duration bonds from long-duration bonds. Plan sponsors may need to use specialist firms to invest in nontraditional hedges, although he says more traditional LDI players are starting to offer these kinds of diversifying asset classes.
“They know they have an audience that is going to be a natural buyer of them,” he says.
With plan sponsors’ liability needs changing, they may rethink using a custom blended benchmark with a single manager in favor of multiple managers skilled in different slices of the yield curve. It might be a successful approach for plan sponsors with larger hedge programs.
“If you separate it into a few more discrete components, each component is now large enough to encompass one or more managers at a price point that is attractive to the pension sponsor that may be the best of all possible worlds,” Gross says.
Tags: corporate defined benefit pension funding level, liability hedging, liability-driven investments