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Propose and defend an asset allocation designed around a set of liabilities

CFA® Level III · Asset Allocation · Principles of Asset Allocation · L3.AA.4.l

The idea

Begin with funded status and the sponsor's risk tolerance. With assets of 110 and liabilities valued at 100, the surplus is 10; a basic two-portfolio design puts 100 into a hedging portfolio matching liability duration and 10 into return-seeking assets. If the plan is underfunded, the basic design fails and a partial hedge or higher return-seeking allocation is needed, possibly with a glide path that raises the hedge ratio as funded status improves. Other drivers include liability duration and inflation sensitivity, sponsor contribution capacity, and regulatory funding rules. A good justification states the hedge ratio, explains how surplus volatility is controlled, and links the return-seeking size to the funding gap. The trap is judging the allocation on asset volatility alone.

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