Commentary: 3 illusions that can undermine pension investor aims

Capital Group's Colyar Pridgen, lead pension solutions strategist, argues in a commentary published in Pensions & Investments that pension investors can be undermined by illusions driven by their own good intentions. He identifies three: false precision, false humility, and false liquidity. The piece notes that the views are the author's and were submitted and edited under P&I guidelines, but are not the product of P&I's editorial team.

False precision, the most widely acknowledged of the three, appears when LDI strategies seek an overly ambitious degree of exactness despite many uncontrollable factors. Pridgen cites a completion manager that trades swaps without being able to articulate its service costs, potentially incurring unnecessary transaction costs, and a cash flow matching manager that ignores the possibility of pension risk transfer, potentially sacrificing diversification and returns. He also points to the common LDI chart showing perfectly aligned key rate duration exposure, which looks exact on paper but may not hold in real-world outcomes.

False humility concerns stochastic modeling, which forecasts thousands of scenarios in contrast to the handful analyzed by deterministic models. Pridgen acknowledges its strengths in capturing interactions, asymmetries and unintuitive effects. However, he warns that stochastic models embed countless micro-assumptions, and their percentile exhibits can foster overconfidence that the midpoint is a robust single expected answer or that actual outcomes must fall within the displayed range. He advises communicators to convey genuine humility about both modeled outcomes and the strategic conclusions drawn from them.

False liquidity addresses the tension in derivatives-based hedging. Pridgen notes that instruments such as U.S. Treasury futures are highly liquid and capital efficient, which is a primary reason for their wide use in LDI. Yet leverage and collateral requirements can strain sponsors when markets move against their positions. He cites 2022, when rates rose quickly: U.S. and especially U.K. plan sponsors faced substantial capital injections to maintain leveraged hedges. Without appetite to contribute to well-funded plans, sponsors often had to sell illiquid alternatives on unfavorable terms or allowed the denominator effect to push illiquid holdings above target allocations. He recommends that sponsors assess how to meet plan liquidity needs holistically across market scenarios rather than selecting hedging instruments on liquidity or capital efficiency alone.

Pridgen concludes that precision, humility and liquidity are valuable virtues, but each becomes counterproductive when pursued as perfection. The lesson, he writes, is to recognize the limits of each, since perfectly forecasting future outcomes and risks is illusory. Pension investors may be better served by emphasizing resilience and adaptability and by building portfolios that can withstand a wide range of possible futures.