CMMU Faculty Latest Publication on Asset Liability Management

Defined benefit pension plans accumulate assets with the objective of eventually paying the pension benefits promised to the plan participants. The pension liabilities (the present value of the promised payments) should be at the center of designing investment policies and serve as the ultimate benchmark for evaluating risks and measuring performance. The goal of the investment policy should be to maximize expected excess returns over the liabilities, subject to an acceptable level of risk that is expressed relative to liabilities. In this article, we argue for the use of a liability-relative drawdown optimization approach to construct investment portfolios. We find that drawdown optimal portfolios provide better downside protection and are better diversified, while providing higher expected returns compared to surplus variance portfolios.