BEST PRACTICES: Asset Allocation for Defined Benefit Plans Flashcards
State and local government retirement systems should establish, within their overall investment policy, an asset allocation plan.
What is the ultimate goal of a defined benefit (DB) plan?
To provide the retirement benefits promised to retirees in state and local government public employee retirement systems by generating sufficient investment returns.
Why is asset allocation fundamental to investing for DB plans?
It divides the investment portfolio among different asset categories (equities, fixed income, cash equivalents, alternatives) to diversify and protect against significant losses by balancing returns and risks across different market conditions.
How should a DB plan’s portfolio be diversified?
Not only among different asset categories but also within asset categories, to perform differently under various market conditions.
What challenges are associated with determining the appropriate asset allocation model for a DB plan?
No single model fits every plan; the challenge is to pick a mix of assets that offers the highest probability of meeting the plan’s goals at an acceptable level of risk.
What factors should be considered before developing an asset allocation plan?
Legal framework, fiduciary standards, actuarial return and risk expectations, need for growth, income, liquidity, risk tolerance, volatility tolerance, investment time horizons, monitoring guidelines, and compliance procedures.
How often should the portfolio performance be reviewed?
At least annually, preferably quarterly, to ensure compliance with strategic and annual investment targets and to report findings to the Board of Trustees.
What should be avoided when managing a DB plan’s investment portfolio?
Market timing, or buying and selling securities based on attempts to predict the future direction of the market.
How should state and local government retirement systems establish their asset allocation plan?
By working closely with actuaries and advisors to determine expected rates of return, volatility of returns, cash needs, time horizon for achieving objectives, and developing a long-term strategic asset allocation policy.
