Low-Volatility Equity Investing for U.S. Corporate Defined Benefit Plan Sponsors

Low-Volatility Equity Investing for U.S. Corporate Defined Benefit Plan Sponsors KEY TAKEAWAYS For plan sponsors seeking to de-risk their pension plans, low-volatility equity strategies offer the potential to mitigate plan risk without reducing equity exposure. Low-volatility equity strategies have historically exhibited better risk-adjusted returns than corresponding market-cap-weighted indices, by delivering comparable returns with lower volatility. For pension plans seeking to hedge a liability, the correlation of a low-volatility index to a typical pension liability has been consistently higher than the correlation of a comparable market-capweighted index. Our case study suggests that using a low-volatility equity strategy in concert with a liability-hedging fixedincome strategy may contribute significantly to plans risk-reduction efforts. AUTHORS Ognjen Sosa, CAIA Portfolio Manager and Team Leader, Global Institutional Solutions Ed Heilbron Portfolio Manager Dushyant Jhamb, CFA Senior Quantitative and Technology Strategist Howard Lu Quantitative Analyst Tim Choe Quantitative Analyst Tony Peng, CFA Portfolio Manager

In this article, we demonstrate that investing in a low-volatility (low-vol) equity strategy may reduce pension risk by a meaningful amount while maintaining an asset portfolio s equity exposure. Plan fiduciaries who seek to protect their plan s funded status without reducing equity exposure in the plan may find that using a low-vol strategy in concert with a traditional liability-driven investing (LDI) approach leads to the greatest reduction of plan risk. Given the current low level of interest rates, many investment committees that are hesitant to shift additional assets into fixed income could benefit from considering the use of low-vol equity strategies, which can effectively lower plan risk without the use of derivatives or the accumulation of more bonds. This approach may be particularly compelling for a plan that is so large that it poses significant risk to the sponsor s overall financial health, or for plans that are currently underfunded and contemplating eventual termination. DB plan de-risking De-risking has been an important concern for sponsors of U.S. corporate defined benefit (DB) pension plans for some time now. The 2014 Pyramis Global Institutional Investor Survey captured responses from, among others, 191 U.S. corporate pension plans, with nearly 40% ranking either risk management or volatility as their top concern, and the most frequent answer, current funded status, may also incorporate concerns about risk and volatility (Exhibit 1). Indeed, many plan fiduciaries who saw their plan s funded status collapse from the bursting of the tech bubble (2000 to 2002) and then again from the bursting of the housing bubble (2007 to 2009) are doing what they can to reduce the likelihood that another capital-market shock would cause their plan to slide back to a severely underfunded position. Broadly conceived, DB plan risk arises from any circumstance that can widen the gap between the plan s liability and the plan s assets (see Defining pension risk, upper right). De-risking can address any of the conditions that may cause volatility in a plan s funded status. However, our main focus for this article will be on how fiduciaries may address plan risk by restructuring the asset portfolio. Defining pension risk We define risk for a pension investor as the potential to lose funded status. Should the funded status of a plan worsen, future funding requirements will rise, as will pension expense. Stated in another way, pension risk is the risk that the pension asset portfolio underperforms the pension liability. Liabilities are valued using capital-market reference points (e.g., bond yield curves used to calculate the present value of the future pension benefits) and demographic inputs (e.g., lists of plan participants, earned benefit amounts, and expectations regarding life expectancy and work tenure); the liability is said to perform based on how it changes over time. Therefore, risk on the liability side of the ledger is driven by a combination of capital-market performance and workforce evolution, while pension risk, or surplus risk, is driven by the potential for assets to underperform the liability. To help understand pension risk, we further decompose it into capital-market risk in the asset portfolio, and unhedged liability risk. Capital-market risk is simply the effect of volatility embedded in the various market investments of the asset portfolio, while unhedged liability risk is the risk inherent in any mismatch between the liability s performance and that of the asset portfolio. Unhedged liability risk therefore is determined by how correlated the asset portfolio is to changes in the value of the liability. Exhibit 1 Top concerns of plan sponsors regarding the investment portfolio Nearly 40% U.S. corporate pension plans surveyed indicated risk management or volatility as their top investment concern. Current Funded Status 28% Other* 18% Risk Management 20% Low Return Environment 15% Volatility 19% * Other includes those responding with the following answers: Ability of our managers to generate excess return, Participant involvement, Impact of new regulatory and accounting changes. Survey captured responses from 811 institutional investors across 22 countries, including 191 U.S. corporate pension plans. Source: 2014 Pyramis Global Advisors Institutional Investor Survey, Fidelity Investments, Oct. 2014. 2

LOW-VOLATILITY EQUITY INVESTING FOR U.S. CORPORATE DEFINED BENEFIT PLAN SPONSORS De-risking strategies based on portfolio reallocations have generally fallen into three types of policy decisions: extending bond duration to better hedge liability risk; shifting stocks to bonds to reduce the aggregate capital-market risk of the overall portfolio and to hedge liability risk; and, further diversifying the return-seeking portion of the portfolio (i.e., the portion of the portfolio designed to outpace rather than to hedge the liability), which can reduce capital-market risk. One important approach to de-risking has been liability-driven investing (LDI), a strategy in which a plan s assets are repositioned to better match the duration and cash flow properties of the plan s liability. The 2014 Pyramis Global Institutional Investor Survey found that 47% of U.S. corporate pension plans now have an LDI strategy in place, up from 31% in 2008. 1 The main objective of an LDI strategy is to construct an asset portfolio that behaves more like the liability (i.e., shows a higher correlation between the portfolio and the liability), so that capital market movements are less influential on the plan s funded status. By building a portfolio of fixed-income securities that respond to interest-rate changes in ways similar to the liability, an LDI strategy attempts to hedge the capital-market risk embedded in the liability, thereby reducing the risk that a plan deficit worsens substantially. In addition to improving the liability-hedging potential of the plan s bond portfolio, pursuing an LDI strategy may also involve shifting additional portions of the asset portfolio into fixed income, reducing market exposure while hedging more of the liability risk. However, some plan fiduciaries may be reluctant to begin an LDI program or expand an existing one, due to the environ- 1 Source: 2014 Pyramis Global Advisors Institutional Investor Survey, Fidelity Investments, Oct. 2014. The survey includes responses from 191 U.S. corporate pension plans. Exhibit 2 Comparison of rolling volatility The MSCI World Min Vol Index has shown consistently lower volatility than its parent index, including during market dislocations. Volatility 30% 20% 10% 0% World 36m Volatility Min Vol 36m Volatility Difference: World minus Min Vol Volatility Dot-Com Crash Difference in Volatility (percentage points) Global Financial Crisis 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Aug-15 World: MSCI World Index. Min Vol: MSCI World Minimum Volatility Index. See appendix for important index information. Min Vol data prior to Apr. 14, 2008, is backtested. Past performance is no guarantee of future results. Source: MSCI, FactSet, Fidelity Investments, as of Aug. 31, 2015. 3

ment of low interest rates or the anticipation of a possible rising-rate regime. For plan sponsors hoping that higher discount rates will reduce the value of the liability and optimistic that continued strong equity returns may shrink a funding gap increased exposure to fixed-income securities may not be an attractive option. Low-vol equity strategies Simply stated, low-vol portfolios are constructed using quantitative models to select a set of investments that, within a defined set of constraints, minimize expected volatility. The most common constraints attempt to mitigate concentration risk and transaction costs by setting limits for individual stock weights and portfolio turnover. Sector constraints may also help a lowvol portfolio to better represent the broader market. 2 For example, the MSCI World Minimum Volatility Index, which we use in the analysis for this article, is constructed by optimizing the collection of stocks within the MSCI World 2 For a refutation of the common criticism that low-vol investing is primarily a sector play, see Leadership Series article Prudent Growth with Low- Volatility Equity Investing. Exhibit 3 Volatility and Sharpe ratio (3/1997 to 8/2015) Over the full period from 1997 to 2015, the low-vol world equity index has shown lower volatility and higher risk-weighted returns than its parent index. Volatility 16% 12% 8% 4% 0% Volatility Sharpe Ratio 0.31 MSCI World Index 0.45 MSCI World Minimum Volatility Index Sharpe Ratio Sharpe ratio: compares portfolio returns above the risk-free rate relative to overall portfolio volatility. See appendix for important index information. Min Vol data prior to Apr. 14, 2008 is backtested. Past performance is no guarantee of future results. Source: MSCI, FactSet, Fidelity Investments, as of Aug. 31, 2015. 0.4 0.3 0.2 0.1 0.0 Index to achieve the lowest forecast volatility portfolio, given the expected volatility and covariance structure, within a set of constraints. 3 In this way, the MSCI World Min Vol Index is investable and transparent, and provides a benchmark for discerning risk-and-return differences between a marketcapitalization-weighted index (the parent index, MSCI World) and a generic low-vol equity strategy. (For a discussion of actual low-vol investment strategies, see Why choose active fundamental low-volatility strategies? on page 5.) As the name implies, the primary goal of a low-vol equity strategy is to reduce the overall volatility of an equity portfolio. Common equity indices, such as the S&P 500, MSCI EAFE, and MSCI World, are weighted by market cap, and they suffer from structural biases that can magnify volatility. (For example, well-performing high-beta stocks tend to make up a disproportionate share of the index as their valuations are stretched, and thus can contribute more to overall volatility.) A low-vol equity strategy is intended to be useful to investors who are seeking to reduce market risk in their portfolios while maintaining equity market exposure. Historically, low-vol equity strategies have fulfilled this expectation. Exhibit 2 (page 3) shows the rolling 36-month volatility of the MSCI World Min Vol index relative to its market-cap-weighted parent index. Over the whole period, the minimum-volatility index averaged a 26.2% risk reduction from the market-capweighted index; in addition, the risk reduction was generally most prominent when overall market risk was higher. Low-vol equity indices may sacrifice some short-term performance relative to capitalization-weighted indices, particularly in bull markets. 4 However, the compensation has 3 Constraints for the family of MSCI Minimum Volatility Indices include absolute minimum and maximum constituent weight, minimum and maximum sector, country, and risk exposure weights relative to the parent index, and a maximum one-way turnover ratio. 4 Historically, over longer cycles, low-volatility strategies have not significantly lagged corresponding cap-weighted indices. This lowvol anomaly is the source of some considerable debate, as lowvolatility indices have only been in existence for a short time and there are methodological disputes concerning backtesting them over longer periods. Many have argued, and we would agree, that there is reasonable justification to suspect the return comparability may persist, due to behavioral and market factors influencing the returns of marketcapitalization-weighted indices. If this is true, low-volatility strategies may be especially appropriate for long-term investors willing to accept shortterm underperformance in exchange for greater downside protection without a longer-term cost to performance. 4

LOW-VOLATILITY EQUITY INVESTING FOR U.S. CORPORATE DEFINED BENEFIT PLAN SPONSORS been consistently better Sharpe ratios (Exhibit 3, page 4). In other words, for investors who are motivated by risk-adjusted returns (rather than by returns alone), low-vol equity strategies have offered compelling results. Low-vol equity strategies for pension investors Because low-vol equity strategies are associated with lower risk and favorable risk-return profiles over longer investment horizons, they may be an especially attractive option for plan fiduciaries seeking to de-risk their pension plans. By reallocating some of the asset portfolio out of marketcapitalization-based approaches and into low-vol strategies, a plan can reduce capital-market risk in the asset portfolio while still maintaining equity exposure. In addition, another quality of low-vol equity strategies may be of particular interest to plan fiduciaries who are concerned about risk reduction: Historically, the low-vol equity Why choose active fundamental low-volatility strategies? Typical low-vol equity strategies tend to use historically estimated risk models or weighting schemes that have performed well in historical portfolio simulations. These strategies use broad quantitative frameworks that may lack deep understanding of the underlying individual stocks in the portfolio. As a result, portfolio construction methodology is backward looking; it is not designed to respond flexibly to changes in risk regimes or unusual risk-return catalysts. Fundamental analyst research adds the potential for in-depth forward-looking views, particularly on risk-return catalysts, which are most fluid in times of market stress. Low-vol strategies that incorporate both backward-looking and forward-looking (active fundamental) elements may yield better results than either approach on its own. Coupling a quantitative risk management framework with the depth and breadth of fundamental analyst industry knowledge may lend diverse insights that enhance both the risk and the return characteristics of low-vol investing. Exhibit 4 Monthly return correlations of assets with a liability proxy (3/1997 to 8/2015) Historically, the MSCI World Minimum Volatility Index has shown greater correlation to a pension liability proxy and to long-duration bonds than other typical return-seeking exposures, suggesting that low-vol strategies may have some limited potential for use in hedging a pension liability. Monthly Return Correlation 100% 100% 97% 80% 60% 40% 20% 22% 9% 7% 6% 0% 1% 20% Liability Proxy Barclays Capital Long US Corporate Index MSCI World Minimum Volatility Index Dow Jones-UBS Commodity Index Greenwich Global Hedge Fund Index MSCI World Index LPX50 Global Private Equity Index World: MSCI World Index. Min Vol: MSCI World Minimum Volatility Index. See appendix for important index information. Min Vol data prior to Apr. 14, 2008, is backtested. Past performance is no guarantee of future results. Source: MSCI, FactSet, Fidelity Investments, as of Aug. 31, 2015. 5

index has exhibited higher correlation to a pension liability proxy than other typical return-seeking investments. As with an LDI strategy, a higher correlation suggests greater potential to hedge movements in the value of the liability, helping to maintain funded status when, for example, the discount rate changes. Using a simple proxy for a plan s liability (50% Barclays Long Corporate A or Better and 50% Barclays Long Government Credit), we can examine the correlations between typical pension liabilities and various asset classes that a plan fiduciary might use to de-risk a plan. Exhibit 4 (page 5) demonstrates that, as expected, long-maturity investment-grade fixed income strategies have shown the highest correlation to the liability proxy. However, the MSCI World Min Vol Index has shown greater correlation (22%) than market-cap-weighted developed-world equities (7%). Likewise, the MSCI Min Vol Index showed a higher correlation than indices of various other investments that are frequently used as diversifiers in pension portfolios. Moreover, the correlation of the low-vol index to the liability proxy has remained consistently higher than the correlation of the market-cap index to the liability proxy (Exhibit 5). The Exhibit 5 Comparison of rolling correlation Although the difference varies, the MSCI World Min Vol Index has consistently shown higher correlation to a liability proxy than its parent index. Correlation to Liability 0.8 Liability vs. MSCI World Min Vol Liability vs. MSCI World Difference Correlation Difference 0.40 0.6 0.35 0.4 0.30 0.2 0.25 0.20 0 0.15 0.2 0.10 0.4 0.05 0.6 0 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Aug-15 See appendix for important index information. Min Vol data prior to Apr. 14, 2008, is backtested. Past performance is no guarantee of future results. Source: MSCI, FactSet, Fidelity Investments, as of Aug. 31, 2015. 6

LOW-VOLATILITY EQUITY INVESTING FOR U.S. CORPORATE DEFINED BENEFIT PLAN SPONSORS benefit, for those seeking to reduce funded status volatility without reducing equity exposure, is a decrease in plan risk both through a reduction in equity volatility and an improved liability hedge. Global low-vol equity in action: a hypothetical case In order to quantify the effect of using a low-vol strategy on a pension plan, we formulated a hypothetical representative asset portfolio using data from pension plan surveys by Pyramis Global Advisors (Fidelity Investments). We assume an 80% plan funded ratio for our analysis to reflect a plan that may be interested in de-risking but may still want to maintain return-seeking exposure to help address the funding gap. Using this hypothetical plan, we first calculate the impact of establishing a basic LDI strategy by reallocating all fixed- Exhibit 6 Asset allocations for our hypothetical representative pension plan. Representative Policy Mix Adjusted Exposures for Case Study U.S. Equity 33% 13% International Equity 20% World Equity (50% U.S., 50% International) 40% Alternatives 10% 10% Fixed Income 37% 37% income assets to a passive long-duration mandate. 5 We also apply a generic low-vol strategy to the equity component of the portfolio (recategorizing somewhat to reflect that about half of the MSCI Min Vol World Index is actually U.S. equity; see Exhibit 6). This analysis shows meaningful risk reduction related to adopting both LDI and low-vol equity strategies, while the greatest benefit would result from employing both strategies in concert. Exhibit 7 (page 8) quantifies our results. We define plan risk as the potential to lose funded status and model it by computing surplus value-at-risk (surplus VaR). VaR is typically expressed in dollar terms; we express the surplus VaR as a percentage of the total liability, in order to represent it in terms of the potential reduction in funded status should a significant market event take place. For example, if the funded status of a plan is 90%, and the surplus VaR is 20%, then a serious capital market shock could cause the funded status to fall to 70% (and possibly lower) over the course of a one-year period. As a point of reference, many plans suffered losses of funding status similar to or greater than their surplus VaR during the bursting of the tech bubble, and again during the global financial crisis. In our representative portfolio, moving the entire fixed-income investment component from the Barclays Aggregate Index into a hypothetical LDI strategy lowers the surplus VaR by 18.6%, an 18.6% reduction in risk, by lowering surplus VaR from 17.7 to 14.4. In addition, the reallocation of most of the equity portfolio to a low-vol strategy further reduces the surplus VaR by an additional 17.4% (from 14.4 to 11.9). Overall, our case study demonstrates that even without changing the asset mix, a typical pension plan could reduce plan risk by more than 30% by combining extending the duration of the fixed-income allocation with a low-vol equity strategy. Total 100% 100% Starting with the survey results, U.S. equity and international equity exposures are redistributed as U.S. and world exposures. The portfolio exposures are identical, but redistributing allows us to model the world exposure using both a market-cap-weighted approach (MSCI World) and a low-vol approach (MSCI World Minimum Volatility), while maintaining the remaining U.S. equity exposure in a market-cap-weighted index strategy (S&P 500). See appendix for important index information. Source: Pyramis Global Advisors, Fidelity Investments, as of Oct 29, 2015. 5 Barclays Aggregate Index used as a proxy for fixed income; 50% Barclays Long Corporate A or Better and 50% Barclays Long Government Credit used as a proxy for an LDI strategy. Actual LDI strategies are often customized to the particular qualities of the plan s liability. Because we have used the same generic proxy for both the liability and the LDI strategy, the match between liability returns and LDI portfolio returns is tighter than it may be in practice. For a discussion of customization and matching returns, see Leadership Series article Active Management for Your LDI Program, Apr. 2014. 7

Each approach mitigates risk in a different way, which allows the results to be incremental. As illustrated in Exhibit 8, shifting fixed-income exposure to an LDI strategy primarily reduces unhedged liability risk, with a lesser impact on the plan s exposure to capital-market risk. Shifting equity exposure to a low-vol strategy reduces capital-market risk directly, and could also lessen unhedged liability risk somewhat, due to the positive correlation of low-volatility strategies with long-duration bonds. In practice, plan fiduciaries may find that at various stages of de-risking and in various market environments, it may be particularly useful to employ strategies that allow them to de-risk within the parameters of established longer-term asset class exposures. Just as adopting an LDI strategy can provide risk-mitigation benefits even before increasing the allocation to fixed income, the initiation of a low-vol equity strategy may lower overall plan risk while maintaining the same allocation of assets to equity. Moreover, the use of low-vol equity strategies may benefit plan funded status particularly during times of market stress. When we test our representative asset portfolio against market returns for the two most recent market crises (reflecting the period for which we can use comparable index returns), we find that a combination of generic LDI and low-vol equity Exhibit 7 Surplus VaR Both LDI and low-vol strategies can reduce risk in the model plan; combining both strategies lowers surplus VaR even more. Surplus % VaR 18 16 14 12 10 8 6 4 2 0 17.7 Market Cap Equity & Agg Bonds 15.3 Low Vol Equity & Agg Bonds 14.4 Market Cap Equity +LDI 11.9 World Low Vol Equity+ LDI Surplus VaR: Surplus VaR expressed as a percentage of the total liability. See Exhibit 6 for representative exposures. Market Cap Equity: all world equity exposure (40% of assets) in MSCI World Index. Agg. Bonds: all fixed income exposure (37% of assets) in Barclays Aggregate Index. Low-Vol Equity: all world equity exposure in MSCI World Min Vol Index. LDI Bonds: all fixed-income exposure in 50% Barclays Long Corporate A or Better and 50% Barclays Long Government Credit. Representative portfolio exposures also include U.S. Equity in S&P 500 (13% of assets), and Alternatives in Greenwich Global Hedge Fund Index (6%), Morningstar World Real Estate AW (3%), LPX Global Private Equity Index (1%). See appendix for important index information. Source: FactSet, Bloomberg Finance L.P., Morningstar, Fidelity Investments, as of Aug. 31, 2015. Exhibit 8 Surplus VaR: Risk decomposition estimate LDI and low-vol strategies differ in the types of risk most directly addressed. Surplus % VaR 18 16 14 12 10 8 6 4 2 0 5.0 12.7 Market Cap Equity & Agg Bonds 4.8 10.6 Low Vol Equity & Agg Bonds Capital-Market Risk Unhedged Liability Risk 2.0 12.5 Market Cap Equity + LDI 1.6 10.3 World Low Vol Equity + LDI Capital-market risk: the aggregation of the volatility embedded in the various market investments of the asset portfolio. Unhedged liability risk: volatility in plan funded status caused by unhedged changes in the value of the liability. See Exhibits 6 and 7 for representative exposures and indices used. Decomposition estimate uses a proprietary risk model. For illustrative purposes only. Numbers may not sum to totals in exhibit 7 due to rounding. Source: FactSet, Bloomberg Finance L.P., Morningstar, Fidelity Investments, as of Aug. 31, 2015. 8

LOW-VOLATILITY EQUITY INVESTING FOR U.S. CORPORATE DEFINED BENEFIT PLAN SPONSORS strategies would have performed quite well (Exhibit 9). From beginning to end of the dot-com crash and the global financial crisis, the combined strategy did the best job in preserving funded status. Additionally, the combined strategy provided the lowest volatility of plan surplus for each period. Implications for DB pension plans Historically, low-vol equity strategies would have helped to protect funded status, without the use of complex derivatives. Therefore, we think low-vol equity strategies may be particularly attractive to corporate plan fiduciaries who are sensitive to funding or funded status volatility but are reluctant to increase exposure to fixed income. As demonstrated, converting equity exposure to a low-vol approach and reconstructing the bond portfolio to better hedge the liability may decrease plan risk by 30% or more for some plans. The implication for plan fiduciaries may be greater than just more restful sleep during turbulent markets we believe low-vol equity strategies can contribute to meaningful risk reduction, without major policy changes. Exhibit 9 Impact of de-risking following a market crisis Market Cap Equity & Agg Bonds Market Cap Equity & LDI Bonds Low Vol Equity & Agg Bonds World Low Vol Equity & LDI Bonds Min Vol minus World Index Returns (left chart, left axis) Comparison of Index Returns & Plan Funded Status Following Market Events Comparison of Volatility (Standard Deviation) of Plan Surplus During Market Events Min Vol minus World Index Returns over Period 25% Plan Funded Status at End of Period (80% Starting Status) 80% Volatility of Plan Surplus 16% 20% 70% 12% 15% 10% 60% 8% 5% 50% 4% 0% 1999 Dot Com Crash Dec-99 through Sep-02 Global Financial Crisis (GFC) Mar-08 through Feb-09 GFC & Rebound Full Period Mar- 08 through Aug-15 40% 0% 1999 Dot Com Crash Dec-99 through Sep-02 Global Financial Crisis (GFC) Mar-08 through Feb-09 GFC & Rebound Full Period Mar-08 through Aug-15 See Exhibits 6 and 7 for representative exposures and indices used. Past performance is no guarantee of future results. See appendix for important index definitions. Beginning plan funded status for each period assumed to be 80%. Source: FactSet, Bloomberg Finance L.P., Morningstar, Fidelity Investments, as of Aug. 31, 2015. 9

AUTHORS Ognjen Sosa, CAIA l Portfolio Manager and Team Leader, Global Institutional Solutions Ognjen Sosa is a team leader and portfolio manager at Fidelity Institutional Asset Management, a Fidelity Investments company. In this role, he manages custom multi-asset-class portfolios for institutional clients. Additionally, he leads asset allocation policy discussions with defined benefit clients. He is a Chartered Alternative Investment Analyst (CAIA) charterholder. He joined Fidelity in 2007. Ed Heilbron l Portfolio Manager Ed Heilbron is a portfolio manager at Fidelity Institutional Asset Management, a Fidelity Investments company. He manages custom multi-assetclass portfolios for clients of the Global Institutional Solutions group. Additionally, he leads asset allocation policy discussions with defined benefit clients. He joined Fidelity in 2006. Dushyant Jhamb, CFA l Senior Quantitative and Technology Strategist Dushyant Jhamb is a senior quantitative strategist at Fidelity Institutional Asset Management, a Fidelity Investments company. He conducts research and develops quantitative models to support portfolio managers, and designs and implements technology solutions for the Global Institutional Solutions group. He is a Chartered Financial Analyst (CFA) charterholder. He joined Fidelity in 2007. Howard Lu l Quantitative Analyst Howard Lu is a quantitative analyst at Fidelity Institutional Asset Management, a Fidelity Investments company. In this role, he is responsible for quantitative stock selection modeling and portfolio management. He joined Fidelity in 2008. Tim Choe l Quantitative Analyst Tim Choe is a quantitative analyst at Fidelity Institutional Asset Management, a Fidelity Investments company. In this role, he is responsible for quantitative stock selection modeling and portfolio management. He joined Fidelity in 2006. Tony Peng, CFA l Portfolio Manager Tony Peng is a portfolio manager at Fidelity Institutional Asset Management, a Fidelity Investments company. In this role, he manages custom multi-asset class portfolios for clients of the Global Institutional Solutions group. In this capacity, he also sits on the Business Cycle Board within Fidelity s Global Asset Allocation organization. Tony is a Chartered Financial Analyst (CFA) charterholder. He joined Fidelity in 2006. Fidelity Vice President Stephen Benjamin, CFA, CAIA, and Sector Specialist Taylor Wood contributed to this article. Fidelity Thought Leadership Vice President Vic Tulli, CFA, provided editorial direction. 10

LOW-VOLATILITY EQUITY INVESTING FOR U.S. CORPORATE DEFINED BENEFIT PLAN SPONSORS Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity s products or services. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans generally offer higher yields compared to investment-grade securities, but also involve greater risk of default or price changes. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Past performance is no guarantee of future results. Neither asset allocation nor diversification ensures a profit or guarantees against a loss. Investing involves risk, including risk of loss. All indices are unmanaged, and an investment cannot be made in any index. The concept of risk-adjusted return attempts to quantify the amount of risk taken to achieve a given level of return. Index definitions The S&P 500 Index, a market-capitalization-weighted index of common stocks, is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates. Barclays U.S. Aggregate Bond Index is an unmanaged, market-valueweighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgagebacked securities with maturities of at least one year. Barclays Long U.S. Government Credit Index includes all publicly issued U.S. government and corporate securities that have a remaining maturity of 10 or more years, are rated investment grade, and have $250 million or more of outstanding face value. Barclays Long Corporate A or Better Index includes all corporate bonds in the Barclays Credit Index rated above Baa1/BBB+ with at least 10 years until maturity; Barclays Credit Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered, dollar-denominated, have at least $250 million in par outstanding, and be rated investment grade by at least two of the following three ratings agencies: Moody s, S&P, Fitch. Greenwich Global Hedge Fund Index is composed of funds that report to the Greenwich Database, in order to provide a representative monthly overview of the hedge fund universe. LPX50 is a global index that consists of the 50 largest liquid listed private equity companies covered by LPX. Morningstar World Real Estate AW Index is an asset-weighted index that includes REITs, mortgage companies, and property management companies. MSCI World Index is a free-float-adjusted, market-capitalization-weighted index designed to measure the equity market performance of developed markets. MSCI World Minimum Volatility Index is calculated by optimizing the MSCI World Index for the lowest absolute risk, within a given set of constraints. It was launched on Apr. 14, 2008; data prior to the launch date is backtested data; there may be material differences between backtested data and actual results. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. If receiving this piece through your relationship with Fidelity Institutional Asset Management (FIAM), this publication may be provided by Fidelity Investments Institutional Services Company, Inc., Fidelity Institutional Asset Management Trust Company, or FIAM LLC, depending on your relationship. If receiving this piece through your relationship with Fidelity Personal & Workplace Investing (PWI) or Fidelity Family Office Services (FFOS), this publication is provided through Fidelity Brokerage Services LLC, Member NYSE, SIPC. If receiving this piece through your relationship with Fidelity Clearing and Custody Solutions or Fidelity Capital Markets, this publication is for institutional investor or investment professional use only. Clearing, custody, or other brokerage services are provided through National Financial Services LLC or Fidelity Brokerage Services LLC, Member NYSE, SIPC. 11

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