Implications of Indexing in Liability-Driven Strategies

As a fixed income portfolio manager for a large pension fund, you are implementing a liability-driven investment strategy to ensure that the fund can meet its long-term obligations. Recently, the fund has decided to adopt a benchmark indexing approach for its fixed income portfolio. The index selected is designed to closely match the duration and cash flow characteristics of the fund's liabilities.

During your analysis, you come across three different scenarios regarding the implications of indexing on your portfolio’s risk profile and liabilities. Consider these scenarios carefully before selecting your answer.