Asset Liability Matching (ALM) is a critical risk management tool that ensures an organisation’s assets are aligned with its liabilities so that obligations can be met when they fall due. The collapse of Silicon Valley Bank (SVB) in March 2023 provides a powerful illustration of what can happen when assets and liabilities are poorly matched. SVB held a large share of short-term deposits that could be withdrawn quickly. However, it invested much of this money in long-dated fixed income securities. When interest rates rose sharply, the market value of those securities fell. Although the losses may have been manageable if the securities had been held to maturity, rapid withdrawals forced SVB to realise the losses, contributing to its collapse.
The same principle applies to pension funds, even though the risk is usually less visible. A pension fund must ensure that member
records, benefit payments, bank balances and investment portfolios remain aligned. ALM can be defined as the process of comparing liabilities with the assets that are intended to back them, rather than comparing total assets with total liabilities in aggregate. An asset is properly matched to a liability when it behaves in the same way as that liability under different scenarios. This avoids the misleading comfort that can arise from comparing “apples with oranges”.
Pension funds typically hold different types of assets for different purposes. Bank accounts are used for receiving contributions, paying claims and expenses. Investment portfolios, such as equities and property, are used to generate returns that can exceed inflation and protect members’ purchasing power over the long-term. These investment assets carry risk, but they are necessary for long-term retirement savings. The analysis becomes more complex where funds offer lifestage portfolios. Younger members may be invested in a growth portfolio, members approaching retirement may move to a moderate portfolio, and older members may be invested in a conservative portfolio. Each portfolio has a different risk profile and expected return, so ALM must be performed separately for each portfolio rather than at fund level only.
Several sources of mismatch can arise in practice. Monthly pricing creates timing delays because member values are updated only at month end, while cash and investment movements may occur later. For example, contributions may be credited to member records at the end of March, but the employer may only pay the money in April, with a further delay before it is invested with asset managers. During this period, liabilities may grow before the matching assets are in place. Similarly, claims paid during a month may be based on the previous month end value plus bank interest, while the assets backing those liabilities remain exposed to market movements. If markets rise or fall during the delay, the fund can experience timing profits or losses.
Lifestage switches are another risk. When a member reaches the age at which they should move from one portfolio to another, the member record may be updated before the corresponding asset switch is processed by the asset manager. Because the portfolios earn different returns, any delay can create a deficit or surplus. These switches can involve large balances, making the financial impact significant.
Operational errors can also create mismatches, including omitted transactions, use of the wrong portfolio, duplicate transactions, incorrect amounts, or complete reversals where investments and disinvestments are processed the wrong way around. Many of these errors have a strong manual processing element and can be reduced through automation, where systems generate transaction instructions and users focus on validation.
In practice, an ALM exercise begins by splitting liabilities according to the assets intended to back them. Amounts owed to third parties and claims ready for payment should generally be backed by bank balances because capital preservation is important. Active members’ savings should be backed by the appropriate investment portfolios. For funds with lifestage portfolios, liabilities should be split according to members’ ages. Adjustments are also needed for transactions in progress, such as contributions accrued but not yet received, claims for exited members not yet disinvested, and switches that have been processed on member records but not yet implemented with asset managers.
Once assets and liabilities are grouped appropriately, the fund can calculate a funding level for each category by dividing adjusted assets by adjusted liabilities. A level above 100% indicates excess exposure, while a level below 100% indicates insufficient assets. This analysis can reveal specific risks that an aggregate comparison would hide. For example, a growth portfolio may be overinvested because members who turned 50 have not yet been switched to the moderate portfolio. The moderate portfolio may then appear underfunded because it has not yet received the assets. A conservative portfolio may also be underfunded if a claims disinvestment was duplicated and not yet corrected. In each case, even a small market movement can create a loss where assets and liabilities are not aligned.
Although this article focuses mainly on defined contribution funds, ALM principles also apply to defined benefit funds, where liabilities must be matched by timing, amount, currency and duration of cash flows. Actuarial factors used to calculate exit benefits should be reviewed regularly so they remain consistent with market valuations.
Daily pricing can reduce some timing mismatches, but it increases operational complexity and cost because calculations rise from 12 monthly valuations to about 250 daily valuations each year. Some assets may also not have reliable daily valuations, making daily pricing impractical.
ALM should not be treated merely as an annual audit or actuarial valuation exercise because mismatches arise continuously. ALM follows a structured process with well-defined inputs hence can be automated and performed monthly or quarterly. Regular ALM allows funds to identify and correct emerging risks before they become deficits. In volatile markets, even small mismatches can quickly become financially material. Pension funds that treat ALM as a routine control will be better placed to protect member outcomes, maintain liquidity and preserve financial stability.
