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The Risk of Delaying Long Duration
Firm: Capital Group
Overview: Many pension plan sponsors are making decisions on allocation to fixed income based on the funded status of their plan, the absolute level of interest rates and the relative value of other asset classes. They may be overlooking another important component — a potential scarcity of long maturity corporate bonds. Should rates rise further and many pension plans seize the opportunity to expand a long duration program, investors could find themselves crowded out by a sharp rise in demand for long credit. A better alternative may be to continue with a planned implementation of a long duration program and make the interest rate exposure a separate decision.

New pension rules shouldn’t derail long duration strategies
Firm: Capital Group
Overview: New federal pension rules that raise the discount rate applied to liabilities for contribution purposes have opened the debate on whether plan sponsors should delay implementation of asset-liability matching long-duration strategies. The new rules, which were included in the transportation bill that President Obama signed in July, may provide relief from the impact of the currently very low interest rates used to calculate liabilities for the purposes of determining minimum contributions under ERISA. Plan sponsors may be tempted to use this relief to reduce contributions and/or shorten duration in anticipation of higher interest rates. However, we believe that plan sponsors should think carefully before doing so, as relief from the law likely will be temporary and higher interest rates don’t necessarily undermine the long-term case for owning long-duration assets.

Implementation challenges of a liability driven mandate & the role of active management
Firm: Loomis Sayles & Company
Authors: the Loomis Sayles LDI Solutions Team
Overview: Two main sources of risk typically drive the variability of a pension plan’s liability. The first is associated with the actuarial assumptions made in computing the value of future cash flows. The second is related to the discount curve used to determine the present value of those cash flows. We believe active investment management is required to address the trade-offs and dynamic decisions these challenges present. Active management supported by comprehensive fundamental research and advancedrisk modeling is essential, not only for seeking to generate alpha but also for managing risks associated with customized liability driven investment (LDI) mandates.

The various roles of fixed income in pension plans
Firm: Loomis Sayles & Company
Authors: the Loomis Sayles LDI Solutions Team
Overview: A defining characteristic of a liability driven fixed income mandate is the alignment of a portfolio’s objectives with the specific role it is designed to play in an overall investment plan. Pension plans typically decompose assets into two groups: “liability hedging” and “return seeking.” While a fixed income allocation is most commonly associated with liability hedging, it can cut across both dimensions to satisfy distinct plan needs, as shown in the chart below. Fixed income assets can help pension plans reduce overall plan volatility, maintain funding ratios and close funding gaps. Plans must consider the different risk/return tradeoffs of these three roles when determining an optimal fixed income portfolio structure.

Reconstructing the Curve:Pursuing the Perfect Hedge
Firm: Loomis Sayles & Company
Authors: the Loomis Sayles LDI Solutions Team
Overview: This paper examines an innovative way of translating a liability stream and discount curve into a set of familiar risk exposures against which portfolios can be managed by applying “shock” scenarios to various clusters of bonds used to construct the curve and observing how the present value of the liability changes. Portfolio managers can use this methodology to manage assets directly against the liability in the same manner and using the same tools they would when managing against a standard third-party benchmark. Of equal importance, this approach forms the foundation for detailed performance attribution to the liability. This attribution can be used to evaluate the performance of a portfolio managed directly to the liability or to better understand the relative performance of a standard third-party benchmark versus the liability.

Is It Still a Good Time to Extend to Long Duration Strategies?
Firm: Prudential Fixed Income
Authors: F. Gary Knapp, CFA, Managing Director and Head of Liability-Driven InvestmentStrategies and Michael Collins, CFA, Senior Investment Officer
Overview: Continued strength in U.S. and global equities, coupled with a surge in long-term U.S interest rates after the Federal Reserve hinted at tapering its asset purchase program, have placed many corporate pension plans in a better position to advance their de-risking strategies. Accordingly, many pension plans are considering an increased allocation to longer duration fixed income strategies to reduce the mismatch, and resulting tracking error, between their plans' assets and liabilities. For many plan sponsors, we believe simply extending the duration of their existing fixed income allocation from intermediate term to longer term could lead to improved outcomes, even in an environment in which the Federal Reserve begins raising short-term interest rates.In this paper, we take a brief look at some of the risk/return trade-offs of extending duration under different interest rate and yield curve scenarios. We also look at how the current, historical steepness of the U.S. Treasury yield curve provides an attractive entry point into longer duration high quality bonds, including corporate bonds.

The Low Ranger
Firm: Prudential Fixed Income
Authors: Robert Tipp, CFA Managing Director, Chief Investment Strategist, Head of Global Bonds and Foreign Exchange
Overview: With the Federal Reserve's days of asset purchases presumably numbered, many investors fear that the recent surge in interest rates signals the onset of the mother of all bond bear markets. But we don't think so. From a long-term secular perspective, we believe that most of the decline in yields over the last thirty years is unlikely to be reversed. Past experience suggests sharp sell-offs driven by economic recoveries and fears of Fed tightening, or in this case the Fed’s “Taper,” often represent attractive buying opportunities. Finally, after considering historical trends and the current economic backdrop, we’ve revised down our long-term yield forecast for the 10-year Treasury to 3.0% from our prior forecast of 3.5%, which we originally published in a 2003 paper. Over the near- to medium-term, however, we expect rates to remain below 3%.

Long-Term U.S. Interest Rates: Why History Cannot Be Our Guide
Firm: Prudential Fixed Income
Authors: F. Gary Knapp, CFA, Managing Director, Product Manager Insurance and Liability-Driven Investment Portfolio Strategies and Robert Tipp, CFA Managing Director, Chief Investment Strategist, and Head of Global Bonds and Foreign Exchange
Overview: The European financial crisis has created considerable demand for U.S. government securities. While we expect this demand will subside, we believe that long-term rates will not rise significantly over the next decade for a number of fundamental, structural, and technical reasons. Our longer-term projection, is for the yield on the 10-year Treasury bond to be about 3% (between 1% and 4%). The following brief explains our rationale and concerns.

Managing Corporate Bond Event Risk
Firm: Prudential Fixed Income
Author: Temple Houston, Head of Investment Grade Corporate Bond Research, Prudential Fixed Income
Overview: Prudential Fixed Income provides a look at the economic and market factors driving the recent rise in adverse event risk in the U.S. industrial corporate bond sector and reviews the steps that fixed income investors can take to manage the potential negative impact to their bond portfolios.

DB plan funding after MAP-21
Firm: Russell Investments
Author: Justin Owens, FSA, EA, Asset Allocation and Risk Management Analyst
Overview: Congress recently passed funding relief legislation for defined benefit (DB) plan sponsors in the Moving Ahead for Progress in the 21st Century Act ("MAP-21"). The premise for passing this relief is that discount rates are currently at historically low levels, driven down by unusual Federal Reserve activity designed to spur economic growth. How should these new rules and the current discount rate environment affect the way sponsors fund their plans?

LDI's Journey Toward Greater Customization
Firm: Russell Investments
Author: Bob Collie, Chief Research Strategist
Overview: The basic initial steps of an LDI program are an increase in the portfolio's sensitivity to interest rates and a reduction in equity holdings. These steps are similar no matter who is taking them. However, as the LDI program becomes more advanced and the link between the asset portfolio and the liabilities becomes stronger, a point is reached at which a greater degree of customization becomes necessary. LDI-focused indexes are now available to make this customization easier.

Introducing a new standard in LDI benchmarking: The Barclays-Russell LDI Index Series
Firm: Russell Investments
Authors: Martin Jaugietis, CFA, Director-Head of LDI Solutions; Jeff Hussey, CFA, Global Chief Investment Officer-Fixed Income; and Justin Harvey, Asset Allocation Strategist
Overview: The Barclays-Russell LDI Index Series: investable and transparent indexes specifically designed to benchmark U.S. liability-driven investment portfolios.

Rates Rise and You Lose. Right?
Firm: Russell Investments
Author: James Gannon, FSA, CFA, EA, Director, Asset Allocation and Risk Management
Overview: Many DB pension plan sponsors are concerned about the effects of increasing interest rates on their fixed income portfolios, and some are considering shortening the duration of those portfolios. A potential problem with this approach, identified in a paper last year, is that taking a shorter-duration position is unlikely to result in better performance "unless the expected [interest rate] increase is greater than the increase already priced into the yield curve." If such increase does not occur, staying the course in a longer-duration portfolio is likely to be a plan sponsor’s best approach. This paper updates this analysis with current data.

The Case for LDI in Any Interest Rate Environment: Clarifying LDI Misconceptions
Firm: Standish
Author: Andrew Catalan, CFA,Managing Director, LDI Strategies
Overview: While many investors accept the notion of managing their assets to their expected liabilities in theory, there continues to be a number of misconceptions about liability-driven investing (LDI) that prevent them from implementing such strategies in practice. The current market environment of low interest rates and heightened volatility has only added to investor uncertainty regarding LDI. The following discussion looks at the 10 most common questions we receive from clients, consultants and prospects about LDI. We seek to resolve some of the misunderstandings about what LDI is and is not, clarify how Standish approaches LDI solutions and argue the case for why investors should consider an LDI approach even in a low interest rate environment.

Perspectives on Liability Driven Investing
Firm: Standish
Overview: The LDI framework is a dynamic process that constantly re-evaluates the optimal liability hedge given changing market conditions and funded status. Standish seeks to accomplish this by sharing our analysis through consultation between the client, their advisors, and our portfolio managers.Plan sponsors evaluating an LDI solution should consider Standish’s four-step framework.

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