Matching the duration of a pension plan’s assets to the duration of its liabilities can minimize funding uncertainty associated with unexpected changes in discount rates. Furthermore, a closer look at the durations of bonds and equities, as well as the structure of the liability stream, suggests a clear and intuitively appealing method for choosing a pension fund benchmark asset mix.
A ratio of equities to bonds in the chosen asset mix that is close to the ratio of liabilities attributable to active versus retired lives, all expressed in present value terms, provides a suitable long-term benchmark for active or passive allocation decisions. This simple rule of thumb provides a direct link between the properties of the pension scheme and appropriate investment strategies. The results are both stable and close to the results derived from more rigorous duration-matching solutions.