Rethinking the Asset Allocation Approach for Plan Sponsors

Abstract

Most plan sponsors formulate a single long term asset allocation for their assets, and then spend a great deal of effort to select a number of active managers within each silo of asset class or style. This process, they hope, combines their top down asset class return expectations (beta) with alpha from a diversified set of external active managers.

This structure however ignores the fact that the single most important decision responsible for the risk and performance of the plan is the asset allocation decision, which remains as an undiversified single decision, is in many cases outsourced or done with minimal internal resources, and is the primary cause of many plans having funding gaps.

We argue that the traditional plan sponsor asset allocation process needs to be redesigned, with the maximum amount of effort being directed to this compared to other activities. This paper proposes that a multi-strategy structure should be implemented for plan sponsor asset allocation, using a range of approaches. Different views and methodologies will therefore reduce the plan’s exposure to a single point of failure, and provide diversification where it’s needed most.

Keywords: asset allocation, multi-strategy, diversification

JEL Classification: G10, G11