MALVERN, Pa. — Vanguard has issued an exchange-traded fund geared toward defined benefit plans investing in liability-driven investment strategies, a move industry watchers call unusual.
The ETF, which began trading on the American Stock Exchange Dec. 10, could be the first on the market targeting such a group. The Vanguard Extended Duration Treasury Index Fund tracks the Lehman Brothers Treasury STRIPS 20-30 Year Equal Par Bond index and has a duration of 22 to 27 years. It has 20 holdings and was designed specifically to target pension funds looking to match their assets to their liabilities, said Paul Bosse, a principal at Vanguard and director of the asset allocation group.
But observers question why investors would want to buy into an ETF that offers exposure to separate trading of registered interest and principal securities, or STRIPS, when the STRIPS themselves are so easily accessible. “It’s an unusual application for an ETF,” said Gary Gastineau, co-founder of ETF-provider Managed ETFs LLC, Summit, N.J.
STRIPS are fixed-income securities sold at a discount to face value and mature at par. If a plan is already fully funded, then going into an investment that tracks relatively low-yielding STRIPS is fine, said Jeffrey Feldman, chairman at ETF-manager XShares Group LLC, New York. But “these (DB fund) trustees see themselves as having a dual role — funding liabilities and increasing benefits, so they want to be able to increase alpha,” said Mr. Feldman.
The Vanguard ETF is a good first step for institutional investors starting to draw out their assets and is not meant to replace 100% of a plan’s portfolio, said Mr. Bosse. “Can people buy STRIPS themselves? Sure,” said Mr. Bosse. But Vanguard’s ETF will offer an investor the diversification of various fixed-income holdings while maintaining a constant duration, he said. This means a plan sponsor will not have to buy and sell holdings to maintain the lengthy duration.
Officials at Vanguard expect to see the most interest from small to midsize plans — $500 million in assets and less — that might not have the economies of scale to invest in 20-plus fixed-income vehicles in a cost-effective way, said Mr. Bosse.
Interest in this product is likely to grow as interest in LDI surges, said Mr. Bosse. He acknowledges that right now, Vanguard faces a small target audience for its new fund.
Interest in LDI has boomed following passage of the Pension Protection Act of 2006, which enforces stricter funding rules, and Financial Accounting Statement 158, which moves the funded status of defined benefit plans onto the corporate balance sheet.
Investors have spent the past year or two learning about LDI, but until recently, it was all talk and very little action. Some big names that have taken the plunge include General Motors Corp., New York; Ford Motor Co., Dearborn, Mich.; Boeing Co., Chicago; and the U.S. pension plan for telecom company Alcatel-Lucent, Murray Hill, N.J. (Pensions & Investments, Dec. 10).
Anthony Rochte, senior managing director at State Street Global Advisors, Boston, said he has not come across another ETF targeting pension funds with LDI strategies. SSgA, the second largest ETF provider, does not offer such long-dated ETFs.
The longest-dated ETF SSgA offers is the SPDR Lehman Long Term Treasury ETF with a duration of slightly more than 11 years, said Mr. Rochte. It was launched as part of a suite of ETFs that included an ultra-short fund, an intermediate fund, an aggregate fund and a long-term fund, he said.
“When we launch our products, we don’t launch them geared at a specific market. We let the market decide how they’re going to use them,” he said.
