Asset Allocation At The Cook County Pension Fund Case Solution

1. What is the problem Nickol Hackett faces? How does a defined benefit pension plan work?

Nickol Hackett faces the problem of underfunding of the pension fund. In 2015, the fund was underfunded by 45%, implying that Hackett has to generate a return of 7.5% with 55% of the pension promises made. Employees nearing retirement would need their pension, and Hackett was faced with the challenge of meeting all future obligations. In a defined benefit pension plan, the plan sponsor, or employer, promises the employees a pre-defined payment plan that they would receive at retirement. Employees are promised a lump-sum payoff that is generated and met by investing the fund and making money. 

2. When, if at all, will the pension run out of money? How does the answer depend on the fund's asset allocation strategy?

The pension fund will run out of money if too many employees retire and the fund has to make payments to a lot of employees. Running out of money depends on the fund’s asset allocation because if the fund’s money is stuck in illiquid assets, then the pension fund will not be able to get out its money easily. Also, if the fund has invested in risky assets, and it incurs a loss on its investments, then the fund will run out of money and will be unable to meet its obligations.

3.What is the risk-return profile of each of the different asset classes? Which ones seem best suited for Cook County?

The risk and return profile for each of the different asset classes are as follows:

Equity instruments tend to have a higher risk because of higher volatility, which is why they generate a greater amount of return as compared to bind securities that provide with a lower degree of risk as well as a low level of return. However, the degree of risk and return for the bonds also differ depending on the certainty of the income stream flowing from a particular bond. This is why, government or treasury bonds give a lower yield and also a lower level of risk, unlike corporate bonds whose risk degree is higher, in turn reflecting in the higher return.