70% II 0.30 40% 50% 60% Equity Allocation --Underfunded --g- Exactly Funded Overfunded FIGURE 10.4 Risk-Adjusted Change in Surplus (RACS): Different Funding Levels 0.30 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Equity Allocation --Zero Noise ... -il... Noise Vol. = 2% Noise Vol. = 4% Noise Vol. = 6% FIGURE 10.5 Risk-Adjusted Change in Surplus (RACS) for Overfunded Plan: Different Noise Levels be seen in Figure 10.5: As the noise increases from zero to 2 percent to 4 percent to 6 percent, the optimal equity allocation increases from 20 percent to 30 percent to 50 percent to 100 percent. The bottom line of this analysis is that the more underfunded a plan is, and the more uncertain future liabilities are, the more attractive equity appears relative to fixed income. Even though the analysis in this section is strictly static, the figures and accompanying discussion shed some light on dynamic asset allocation as well. Ceteris paribus, when the funding ratio decreases (perhaps due to dismal asset returns), a fund that is trying to maximize its RACS ought to invest more in equities. Similarly, if the noise in liabilities increases (perhaps due to legislative uncertainty), a fund ought to increase its equity allocation as well.