One of the more frequently asked questions in investment proposal requests for corporate defined benefit (DB) plans is how to approach the balance between active and passive investing. While many investment advisors offer flexibility, plan sponsors are increasingly seeking a structured framework that improves the likelihood of long-term success. Investment committees—and individual members within them—may hold strong opinions about active versus passive shaped by prior experiences, whether positive or negative. However, emerging best practices are beginning to clarify which segments of the portfolio are most appropriate for active management and where passive strategies may offer greater efficiency and simplicity.
Liability-hedging allocations
The most critical area for deploying active management within a pension portfolio is the liability-hedging fixed income allocation. This segment is designed to mitigate interest rate risk by closely tracking the movement of plan liabilities. Best practice is to implement a custom strategy through a separately managed account (SMA) of individual bonds tailored to the plan’s unique liability profile.
Active management in this context offers several key advantages to plan sponsors:
Precise liability matching:
Actively managed SMAs allow for the closest alignment with the plan’s liability cash flows across the yield curve, thereby reducing funded status volatility. There are significant improvements over pooled bond funds—whether actively or passively managed—which may not align as effectively with liability characteristics.
Credit quality control:
Custom SMAs facilitate alignment with high-quality bond requirements associated with pension liability measurements. In contrast, many off-the-shelf bond funds contain higher concentrations of lower-rated securities, which may not meet these standards.
Proactive portfolio risk management:
Active fixed income strategies thoroughly screen credit issuances for signs of financial distress. Passive fixed income strategies respond to downgrades from credit rating agencies and therefore sell issuances from the portfolio after such evaluations have been issued. Credit screening can anticipate financial distress from issuers before rating agency downgrades and can remove the exposures from the portfolio preemptively. This is particularly important for liability hedge portfolios because pension liabilities are not impacted by downgrades and defaults in the same way as bond portfolios.
Return-seeking allocations
Investment committees are increasingly favoring passive strategies in the return-seeking portion of DB portfolios. This segment is designed to grow plan assets—either to close a funding gap or to maintain a surplus position. Equities are typically the primary investments in this bucket, though larger allocations may also include diversifiers such as credit strategies, real assets or other private alternatives.
For frozen plans on a de-risking glidepath, the emphasis is often on predictability and reduced manager-specific risk. As a result, passive equity strategies are commonly preferred—not only for their ability to deliver market-like returns, but also for their lower investment fees, which help reduce the overall cost of running the plan. This approach allows committees to focus their time and attention on more strategic areas such as overall plan health and the impact on glidepath and liability hedging assets.
In contrast, open and ongoing plans with longer time horizons tend to be more receptive to active management. These plans have greater flexibility to absorb short-term volatility and can benefit from the inclusion of diversifying and alternative investments – areas where active management is considered best practice. When thoughtfully implemented, these strategies can enhance diversification and generate excess returns that contribute meaningfully to long-term funding goals.
Glidepath strategy
Lastly, glidepath strategies—which determine the allocation between return-seeking and liability-hedging assets—should be actively managed. Once a glidepath is established, it is considered best practice to monitor trigger points daily, enabling plans to respond quickly to favorable market shifts before conditions change. Relying on monthly or quarterly reviews can result in missed opportunities and increased volatility in plan financials, including the balance sheet and contribution requirements. Timely execution of de-risking moves enhances alignment with funding objectives and improves the overall effectiveness of the glidepath strategy.
