Ehrentreich LDI Consulting & Research provides consulting services on performance measurement and performance attribution for corporate and public DB pension plans. We specialize on strategic asset allocation and liability driven investment (LDI) strategies.
We have developed the "Pension Plan Internal Rate of Return" (PenPIRR), a money-weighted type of return that measures total success for DB pension plans. Unlike standard time- and money-weighted returns, PenPIRR is the only measure than can be meaningfully compared to a pension plan's expected rate of return.
By decomposing PenPIRR we are able to attribute overall pension success to its various constituents. Investment returns are dependent on what the capital markets offer (typically measured in time-weighted returns), and on the particular return sequence with which a time-weighted return is achieved (Path Dependency Effect – measured in money-weighted return space).
Returns on Governance (e.g., the Endogenous Benefit Effect and the Contribution Effect) measure the extent with which plan sponsors are able to convert higher time-weighted returns into lower funding costs.
The neglect of reverse dollar cost averaging and the endogenous nature of pension benefits typically leads to an inappropriate use of asset allocation algorithms and an allocation to return-seeking assets that is too high. We have proposed the existence of an Asset Return – Funding Cost Paradox. According to this paradox, it is likely that lower returning LDI strategies will result in lower funding costs than higher returning, but riskier strategies. What appears to be a paradox in time-weighted return space disappears when seen in the light of the Pension Plan Internal Rate of Return.
Our research has led us to derive the necessary conditions for a sustainable pension framework. Inquiries by journalists and conference organizers are welcome.