Can stocks help mend the asset and liability mismatch?

Stocks are generally used to provide higher returns in the long run. But the dramatic fall in equity prices at the beginning of this century, triggering large underfundings in pension plans, raised the question as to whether stocks can really help mend the asset and liability mismatch. To understand some aspects of this topical issue, we examine whether existing major equity indexes can close this gap, given the liability profile of a typical pension fund. We also compare the non-market capitalization weighted equity indexes recently introduced as Research Affiliates Fundamental Indexes (RAFI) with traditional market capitalization weighted equity indexes from an asset and liability management perspective. The analysis of the behavior of the solvency ratio clearly indicates that interest rate sensitive stocks have a large potential to improve the link between assets and liabilities. Compared with market capitalization weighted equity indexes, RAFI shows a substantially better potential to mend the asset and liability mismatch, while also improving returns.