PLANSPONSOR - August/September 2018 - 51

2.5%, but the long end is likely to rise
by no more than 1%, says Jay Kloepfer,
director of capital markets research at
consultants Callan LLC in San Francisco.
Corporate yields have felt additional
pressure, ironically, due to the demand for
bonds for LDI programs. " As soon as long
yields get above a certain level, pent-up
demand from pension plans pushes them
back down, " Smith notes.
" While Fed actions may not have
moved long rates much, " Kloepfer says,
" they have instead changed the mindset of
corporate sponsors. Most had considered
LDI, but many had dismissed it because
they thought interest rates were too low. "
Consultants and managers accordingly
report new client interest in LDI
programs, although motivated more by
impending tax rate changes, as well as
wishing to protect recent portfolio gains in
stocks. " Last year, we started seeing people
take the initial jump into LDI, " Kloepfer
says. " Plans have had a good run in equities
for five years, so they have some capital
to work with. Sponsors had until August
to contribute for last year, and still claim a
tax deduction at the old rate of 33%, rather
than the new 21% rate. Many are leaping
down their LDI glide paths-toward
higher funded status. "
For an LDI portfolio to function as
a hedge and match movements in the
liability indexes, it has to stick to a narrow
set of investment opportunities: highquality
corporate bonds, Treasury bonds,
and swaps and futures that bring the
portfolio duration in line with that of the
liability.
Still, investment managers are
looking for ways around the pesky low
yields on long-term bonds. Harvey
describes one strategy, which is based
on intermediate-term bonds: " With a
combination of intermediate-term credit
and Treasury derivatives, you can build
a hedging profile that is comparable to
long-term bonds but more efficient[-
i.e., employing less capital-]than just
buying longer physical bonds. With so
little credit premium for longer bonds,
Corporate Bond Yields Have Ticked Up A Little
But Remain Stubbornly Low
AA U.S. corporate bond yield
8%
6%
July average: 3.5%
4%
2%
0%
2008
2010
2012
2014
Source: Federal Reserve Bank of St. Louis, FRED database
the compensation you get per unit of risk
in the five- to 12-year part of the corporate
yield curve is more attractive than what's
in the 12-year-plus part of the market. "
Other managers and consultants
mentioned strategies that stray from
corporate bonds to other fixed-income
classes that pay higher yields. " We wrote
a paper that looked at how insurance
companies manage what are essentially
the same types of liabilities, " says Michael
Buchenholz, pension strategist at J.P.
Morgan Asset Management in New York
City. He notes that they typically hold
many more positions in their portfolios,
while many pension LDI portfolios are
concentrated in relatively few issuers.
He proposes portfolios that invest
KEY POINTS
* Consultants and managers report that plan sponsors previously
hesitant to enter into an LDI program are motivated by impending
tax rate changes, as well as the wish to protect recent portfolio
gains in stocks.
* For an LDI portfolio to function as a proper hedge and match
movements in the liability indexes, it has to stick to a narrow set
of investment opportunities.
* Some managers and consultants are considering strategies that
stray from corporate bonds to other fixed-income classes that pay
higher yields.
PLANSPONSOR.com August-September 2018 51
half in investment-grade corporates and
half in securitized assets. " It matters less
how you categorize the assets, and more
the return your portfolio generates. Other
fixed-income assets can make a lot of
sense when they don't have to fit into the
buckets of LDI hedges or growth assets.
" They may not move exactly with
the liabilities, " he concedes, " but there's
always a shift between the liability and
how you benchmark it. The liability is
always changing, too. A diversified portfolio
would do better. "
Harvey is stricter about the LDI
perspective. " There are some opportunities,
but, in our view, corporate bonds are
the most reliable hedging tools. "
-John Keefe
2016
2018
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