Imposing a cap on the funding ratio, in addition to a floor, has a positive impact on both pensioners and bondholders, while only having a minor negative effect on equity value, a new study by EDHEC-Risk Institute has found.

Entitled Dynamic Investment Strategies for Corporate Pension Funds in the Presence of Sponsor Risk, the paper introduced new forms of dynamic strategies that also take into account the financial strength of the sponsor company. These strategies aim to control sponsor risk by avoiding circumstances where the pension fund is underfunded and the sponsor is unable to make up for the gap.

Implementing risk-controlled strategies aimed at insuring a minimum funding ratio level allows shareholders to gain access to the upside performance of risky assets, while ensuring that pensioners will not be overly hurt by the induced increase in risk, the institute said.

It added that strategies aimed at controlling sponsor risk by providing insurance against the joint occurrence of an underfunded pension plan and a weak sponsor company are found under most circumstances to increase pensioners’ and bondholders’ welfare compared to basic CPPI strategies adapted to the asset-liability management context.

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