The 2012 Cutwater Asset Management Defined Benefit Pension Plan Survey
Author: David R. Wilson, CFA and Kimberlee Lisella - Customized Strategies Group
Overview: The goal of this survey was to gain insights into the investment strategies, risk tolerances and intentions of pension plans as they face market uncertainty, low interest rates and low funded ratios. We also inquired about their willingness to adopt a liability driven investing approach and the thought process around implementing, waiting or shunning the strategy altogether.
Author: Clifford Corso, CIO, Alexander Ng and Vassilis Skylogiannis - Quantitative Strategies Group
Overview: Inflation has been a concern to investors for centuries. In 1780, Massachusetts issued a bond indexed to the market price of corn, beef, wool and shoe leather. Today, investors seeking to protect against inflation often seek shelter in United States Treasury Inflation-Protected Securities (TIPS). These bonds attempt to keep pace with inflation by adjusting their face value upwards in line with the Consumer Price Index (CPI). While TIPS have some attractive attributes, our research shows their inflation hedging abilities can be misleading. Indeed, over long time horizons, TIPS have exhibited virtually no correlation to inflation. Our internal research highlights several considerations and risks you should consider in your own bond portfolio when looking for inflation protection.
Authors: David R. Wilson, CFA and Kimberlee Lisella - Liability Driven Investing Group
Overview: Today, both corporate and public pension plans are beginning to change their mindset. While pension plans are still generally invested in equity and alternative "growth" strategies, change is in the air. The purpose of this paper is to provide a guide for both corporations and public entities who are evaluating LDI as a solution for their pension plans. We will frame the risk that both corporate and public plans continue to take, recommend executable strategies that fit both plan types and describe how to implement these strategies.
Evolving Investment Guidelines Within Investment Policy Statements
Overview: Best practices for traditional fixed income portfolios. Every great financial crisis prompts a series of necessary changes in the way investors approach markets as part of the ever evolving capital system. In considering the credit crisis of 2008 and subsequent recession, many Investment Policy Statements (IPS) continue to utilize investment guidelines drafted prior to the financial market's near-collapse. As such, these guidelines may not account for risk factors that emerged as a result of structural changes in the fixed income market. Increasing interest rate sensitivity and governmental regulatory risks of agency mortgages are just two such changes. Investment guidelines must progress to align investor risk tolerances with the changing fixed income landscape.
Overview: The financial crisis of 2008/2009 and resulting fear of continued underperformance in fixed income have driven many investors to a seemingly more prudent approach: passive investment strategies. However, the likelihood of upward pressure on interest rates may actually make that approach less appealing than an active management strategy with an emphasis on corporate credit. Given the structural changes in the fixed income market, which we described in detail in the first releast of Why Credit Matters (July 2009), more than 70% of the Barclays Capital Aggregate U.S. Bond Index is now highly sensitive to interest rate movements. As such, investors should be aware of this heightened sensitivity as well as the implicit bullish view on interest rates being taken when pursuing a passive investment strategy. Given these implications and challenges, we believe that active fixed income management, particularly individual security selection in corporate credit coupled with robust risk management, is the most prudent strategy for investors to implement in the current environment.
Authors: Gibson Smith, Co-Chief Investment Officer, Co-Portfolio Manager
Colleen Denzler, CFA, Senior Vice President, Head of Fixed Income Strategy
Overview: The world has changed for fixed income investors. The four primary sectors in the fixed income market have essentially converged into two. Interest rate risk in the U.S. is at its highest level in decades. Sector risk/return characteristics have been significantly altered - perhaps permanently. These factors are coming together to create an environment of heightened risk for fixed income investors.
Overview: In the first release of our Why Credit Matters paper in July 2009, we discussed the structural transformation that was underway in the fixed income market and how corporate credit would likely play a critical role in generating superior risk-adjusted outperformance in the new environment. Given the significant interest in this topic and the number of requests we have received for additional information, we have updated the original paper and published a supplement that expands on our thesis and addresses emerging themes in fixed income. Rising interest rates, spread tightening and the U.S. government's support of the mortgage market have potentially serious implications for yield-seeking investors and will be important factors to watch in 2010. As such, we hope that our perspective and continued discussion on this topic are helpful as you develop your thoughts on this evolving asset class.
Firm: Pyramis Global Advisors
Overview:This paper looks at: 1. Leverage in many global economies continues to pose a serious threat to recovery and stability as bond markets continue to test issuers, especially those deemed over-rated, over-leveraged and over-owned. 2. The global debt market is bifurcated: volatile sectors with relatively high yields but often very challenging fundamentals, and perceived safe havens yielding below 2% to 3%. 3. Investors should focus on the changing risk profiles of sovereign issuers - weighing return assymmetry, volatility and liquidity in portfolio construction. 4. Despite a challenging near-term outlook, good opportunities in credit spreads and currencies could be on the other side of the volatility for investors who have preserved capital, and remain liquid, nimble and patient.
A New Perspective on Long Duration Investing
Firm: T. Rowe Price
Authors: Martin Lee, Director of Fixed Income Quantitative Research Group, and Yongheon Lee, Ph.D., Quantitative Investment Analyst
Overview: Study suggests treasuries, TIPS may deliver better outcomes. Growing interst in liability driven investing (LDI) has led many corporate defined benefit sponsors to extend both the allocation and the duration of their fixed income portfolios while lowering exposure to equities, with the goal of reducing the risk of funding volatility and a potential need for additional plan contributions.
Applying Liability-Driven Investing in a Low Interest Rate Environment
Firm: T. Rowe Price
Authors: Peter Austin, Head of Fixed Income Solutions
Overview: Many corporate defined benefit plan sponsors have experienced dramatic declines in funding status since the 2008 financial crisis as U.S. interest rates and bond yields have fallen to record lows. With the Federal Reserve expected to hold short-term rates at near-zero levels into 2014, little relief is in sight. Low yields have led many sponsors to adopt a “wait and see” approach toward plan de-risking, whether through increased fixed income allocations, duration extension, or both. We believe this stance may be suboptimal, given current opportunities to improve yield and reduce funding volatility. De-risking strategies in the current environment could include modestly extending duration to exploit a steep yield curve and shifting to a customized benchmark based on a blend of the Barclays Intermediate Government/Credit and Long Government/Credit indexes to allow for strategic allocations to spread sectors that are more effective at hedging pension liabilities. By exploiting customized fixed income solutions that take advantage of yield enhancement opportunities that are presently available, plan sponsors can make further progress in reducing funded status volatility.
Europe's Debt Crisis: A Front Line Report
Firm: Wellington Management
Overview: This Q&A addresses: 1. Steps recently taken by the European Union and European Central Bank have toughened fiscal rules for member states and improved bank liquidity, but don't address the root causes of the crisis. 2. Pro-growth policies and meaningful steps toward fiscal union are necessary to truly address the crisis. 3. At this time we do not view elevated spreads on European corporate debt as an attractive buying opportunity.
Fixed Income Outlook
Firm: Wellington Management
Overview: This paper addresses: 1. The uneven trajectory of fixed income markets in 2011 seems likely to be repeated in 2012, propelled by many of the same forces. 2. With rates in developed markets in the low single digits, they are unlikely to fall much further. Conversely, policy and economic forces may prevent any meaningful rise. 3. We remain cautious on peripheral European sovereign securities pending steps toward a sustainable resolution to the region's debt crisis. 4. Emerging markets will be vulnerable to period upsurges in risk aversion, but we remain optimistic about the long-term prospects for this asset class. 5. As upcoming regulatory restraints on proprietary trading reduct market liquidity, credit derivatives will be useful tools for controlling transaction costs as well as portfolio risk.