New research from Greenwich Associates suggests that the U.S. asset-management industry is on the brink of revolutionary change as pension plan sponsors look beyond their historic focus on asset growth and investment returns to more holistic strategies for funding pension liabilities.

Greenwich says that this shift could portend radical disruptions for the investment management industry. The departure from traditional pension management practices is most evident in the increasing popularity of innovative products and techniques such as liability-driven investment strategies, absolute return strategies, portable alpha and net-long approaches, according to the research.

The firm says that this shift is being driven by two powerful trends: under-funding and accounting reform. Under-funding poses a danger to defined benefit pension plans — a threat that will only grow as the workforce ages, the firm says. Simultaneously, the transition to mark-to-market accounting rules in the U.S. is reducing the ability and willingness of corporate plan sponsors to tolerate market volatility within their pension funds, and thereby their ability to generate much-needed investment returns, it adds.

“Plan sponsors in both the public and corporate sectors have begun investigating a series of investment and management strategies, some new and some not-so-new, that are designed to achieve some combination of increasing investment returns, limiting portfolio volatility and managing liabilities down over time,” says Greenwich Associates consultant Dev Clifford.

“Although actual usage of these products remains relatively low, there are signs that the current period might well represent the calm before the storm,” says Greenwich Associates consultant Rodger Smith. “Current interest rates make strategies such as liability immunization expensive propositions, while strong global markets have boosted investment returns to the point at which many plan sponsors are now meeting their actuarial assumptions.”

Thanks to these conditions, average funding and solvency ratios improved over the past 12 months, Greenwich says. “Even if such favourable market conditions persist, plan sponsors will continue to seek a different risk/return trade-off in their portfolios and new approaches and products will continue to gain adherents,” says Greenwich Associates consultant Chris McNickle. “Simply put, the two forces driving this change — under-funding and accounting reform — are not going away.”

Greenwich Associates says that about a third of U.S. plan sponsors report that they have adopted new strategies in response to the emerging investment and regulatory environment, and another 30% say they plan to implement new strategies to address these new conditions over the next two years.

When asked which new strategies they have implemented, more than 20% of these plan sponsors cite absolute return strategies. More than 10% say they have implemented portable alpha strategies, and an almost equal proportion say they are using efficient portfolio strategies utilizing derivatives or other synthetic instruments. Fewer than 5% have immunized liabilities.

“Although the proportion of pension funds that have immunized liabilities remains low, it should be noted that the share of corporate funds that have immunized doubled from 3% in 2005 to 6% in 2006,” says Greenwich Associates consultant William Wechsler. “It is our belief that we are seeing the beginning of a trend that could have profound ramifications for defined benefit pensions — and by extension, the investment management industry — in years to come.”