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Asset Allocation Report

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XYZ, Inc.

Asset Allocation Report


                The Investment Committee is the trustee for XYZ, Inc. Defined Benefit Plan. The Committee established the target allocation range for each broad asset class in the Investment Policy Statement, which is presented in Exhibit 1.The Chief Investment Officer (CIO) at XYZ, Inc. can both adjust the allocation to each broad asset class, and reallocate the weights within an asset class. Since the Plan has both direct and indirect holdings in equity and bond, the fund managers can change the asset allocation of the Plan through their investment decisions.

                Since the inception of the Plan 40 years ago, the Committee have been updating and implementing the asset allocation strategies annually. To maintain the fully funded status, the Plan’s investment strategies are mostly defensive. At the beginning of 2016, the total Plan assets are 13.56 billion. From 2015 to 2016, there are a few changes in the Plan’s Asset Allocation Strategies. The first change is the increased holdings in alternative investments, which includes real estate, mortgage-backed securities, and commodities. The second change is the inclusion of derivatives and international assets in the portfolio. The inclusion of foreign investment can reduce the home country bias, and the Plan uses foreign exchange forwards to hedge against foreign exchange risks.

                To evaluate the effectiveness of each allocation decision, the portfolio’s annual total return is broken down into policy contribution, strategic contribution, and manager contribution, which corresponds to the decisions of the Committee, of the CIO, and of the fund managers, respectively.

Exhibit 1. Target Allocation Range

Asset Class      Strategic Allocation        Lower Limit                Upper Limit

Cash                        2%             1%                         5%

Fixed Income                 40%            30%                        50%

Public Equity                 40%            25%                        45%

Alternatives                  18%             0%                         6%

                The Committee seeks to balance the objectives of receiving higher-return in risky assets and reducing volatility in short-term assets. To meet the pension obligation to current retirees, the Plan reserves about 2% cash and invests around 15% in short-term to intermediate-term debt. Since the Plan is expected to be held in perpetuity, the Committee invests more than 50% of the portfolio in long-term assets—around 40% in public equity, 20% in long-term bonds, 8% in private real estates, and 5% in hedge funds. Although a higher return might reduce corporate contribution, the excise tax on the excess plan assets and the higher risk can outweigh the benefits of higher returns. So the main target for the Plan is to maintain fully funded status through diversification and around 35% investment in fixed income.

                During the year 2014 to 2015, the Investment Committee had a few changes in the asset allocation strategies—increasing the investment in international equity and debt to reduce the home-country bias, as well as increasing investment in real assets. Empirical research showed that defined benefit pension plans can achieve higher long-term return by strategically changing the asset allocations, such as reducing their large-cap US stock holdings just before the global financial crisis. So the CIO will make strategic allocation decisions based on the macroeconomic and relevant specific market factors.

                 According to the economic forecast from TradingEconomics.Com, the US GDP growth will be around 2% for the next five years, and the US inflation rate will increase from 1% in 2016 to 2.5% in 2020. To hedge against the risk of rising inflation, the Plan increased its holdings of TIPS and real estate in 2016. The forecast in indicates falling stock prices from 2017 to 2020, so increasing investments in real assets provides diversification benefits. Also the domestic money supply is forecasted to increase, so the CIO proposed to increase alternative investment holdings to hedge against falling interest rate. According to International Monetary Fund, global economic growth is expected to experience a mild pickup in three years, and the emerging economies might have slowdowns and recessions. Based on these forecasts, the strategic allocation decision is to increase holdings in alternative investments to hedge against inflation and equity market risks.


                Over the past 40 years, the Plan has achieved an average annual return of 8.79%, and average annual standard deviation of 7.5%. From 2015 to 2016, the portfolio outperformed the benchmark by 2.3%. The benchmark for evaluating Plan performance is a weighted average of the individual benchmarks for each asset class according to the asset weights in each year. In Exhibit 2, XYZ defined benefit plan performance is compared with that of the benchmark in recent 15 years.

Exhibit 2. Performance Comparison

1 Year

3 Year

5 Year

10 Year

15 Year

XYZ Plan












Value Added






                By decomposing the portfolio return, the aggregate policy contribution is 13.4%, the strategic contribution in 1.3%, and the manager contribution is -0.35% from 2015 to 2016. The manager contribution is negative, because the alpha generated in the active portfolio is less than management fees. The information ratios of some previously selected fund managers have decreased to the bottom 50%. The Committee will select new actively managed funds, and the selection process is in the following sections.



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