Explain the purposes served by liability-based benchmarks

When a portfolio exists to meet obligations, as with a defined benefit pension plan or an insurer, success means keeping pace with the liabilities rather than with a market index. A liability-based benchmark is a portfolio, often of high-quality bonds, whose value moves with the present value of those liabilities, so it captures their sensitivity to interest rates and inflation. It is used to set and judge the strategic asset allocation, to track surplus or funded status, and to size hedging programmes. Asset-based benchmarks remain the right yardstick for individual managers. The trap: a plan can beat its asset benchmark while its funded status deteriorates because rates fell and liabilities grew faster than assets, a failure that only a liability-based comparison exposes.