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Industry voices

Playing the long game: The case for ultralong Treasuries

A few weeks ago, the U.S. Treasury Department indicated it is considering issuing "ultralong" bonds, which would have maturity periods of perhaps 40, 50 or even 100 years. Shortly thereafter, the Treasury Borrowing Advisory Committee, which represents mostly large bond-trading firms, expressed reservations on the proposal, including whether institutions would generate enough demand to warrant such issuance.

We have a different view. We believe ultralong Treasury bonds would generate significant interest from many investors, particularly pension plans and insurance companies. Ultralong Treasuries would help many corporate pension plan sponsors manage interest rate risk associated with long-dated liabilities and their impact on corporate balance sheets today. At more than $2 trillion in combined assets, corporate defined benefit plans represent a considerable potential user group. And such bonds would also broadly benefit institutional markets by making it easier to price ultralong credit securities, which already exist and in which many institutions already invest. Finally, ultralong Treasuries would enhance the pension risk transfer market, bringing transparency to liability pricing and enabling life insurers to hedge the pension liabilities they acquire.

Managing interest rate risk

Many defined benefit plans are obligated to make payouts to plan participants far beyond 30 years into the future. In fact, roughly 15% to 40% of most pension plans' accrued benefit obligations (in terms of future value) will be paid 30 or more years from now. These longer-term pension liabilities are also ultrasensitive to even small interest rate changes. For example, for some open plans, a 1 percentage point change in interest rates could have as much as a 16% impact on the pension liability recorded on the plan sponsor's balance sheet.

The most effective way for plan sponsors to "liability hedge" — that is, to protect their balance sheets from the negative effects of interest rate changes — is to hold assets with similar interest-rate sensitivity as the liabilities. The 30-year Treasury bonds and Treasury STRIPS fall short of that goal for many liabilities that extend more than 30 years from now, while ultralong Treasuries would not. Hence, we believe many plans will be interested in holding ultralong Treasury bonds. (Indeed, in the United Kingdom, where ultralong government bonds comprise more than 15% of all such bonds outstanding, ultralong bonds are already a common component of many pension plans' liability-hedging programs.)

Other tools for hedging interest rate risk, such as bond futures and interest rate swaps, do exist. But fixed-income derivatives can be complex and may be challenging for smaller pensions to implement. For these thousands of smaller plans, ultralong Treasuries would likely be especially attractive.

Not all pension plans are the same, of course, and some plans, particularly those that were frozen many years ago, might be less interested in ultralong Treasuries. The greatest demand would likely come from younger plans that are still open to new participants, and/or still accruing benefits for existing participants.

Help price ultralong credits

The main beneficiaries of 30-year-plus Treasury bonds, as we've noted, would likely be defined benefit plans that will have to make benefit payments more than 30 years from now. But ultralong Treasuries would also provide greater price transparency to existing corporate bonds with maturities of 30 years and beyond.

Credit investors typically compare non-Treasury bonds to Treasuries of the same maturity, analyzing the "spread" — or difference in yield— between the two to determine a price for the non-Treasury bond. Unfortunately, with no ultralong Treasuries, prices for ultralong corporate bonds are difficult to pinpoint. There are more than 100 U.S. investment-grade bonds in the market today with maturities of more than 30 years, and it is worth noting that 16 of these bonds actually have maturities of more than 50 years. The fact that these bonds were successfully issued indicates investors have appetite for ultralong bonds.

If Treasury were to issue bonds of longer maturity than 30 years, all investors — not just pensions, but also endowments, foundations and others — could value them more accurately and reduce transaction costs when trading them.

Watch for changes in 30-year yields

Should the U.S. Treasury issue ultralong bonds, the dynamics of the long end of the Treasury curve could be impacted. As investors digest the type and size of new ultralong issuance, we would expect increased volatility in 30-year Treasury yields. In fact, when the idea of ultralong Treasury issuance was first raised this spring, 30-year yields increased slightly in response.

Of course, many questions still exist, and the exact market reaction to ultralong Treasuries is impossible to predict. Much would depend on how much the Treasury issues relative to investor appetite. Pension plan sponsors and other institutions certainly should keep these dynamics in mind when considering the potential benefits and considerations of ultralong Treasuries.

All in all, we foresee ample demand for ultralong Treasury bonds among corporate pensions and, potentially, other institutional investors – enough to give Washington a good reason to seriously consider the idea. We also see ultralong Treasuries' benefits stretching beyond pensions, to any institution that holds ultralong corporate bonds today or hopes to in the future. If well executed, ultralong issuance could be a boon for many institutional investment markets in the U.S. and around the world.

Jeff Blazek is a managing director based in New York and Alex Pekker is a senior investment director based in San Francisco, for Cambridge Associates LLC. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.