Institutional investors knew this day would come, but not so soon and not at as quick a pace.
After years of persistent low interest rates and correspondingly low corporate and Treasury bond yields, the 10-year Treasury bond yield surpassed 2% intraday on Jan. 28. If sustained (it was 2.02% on Feb. 1), that could alter everything from discount rates and funding to asset allocations.
The yield on the benchmark 10-year Treasury was last above 2% in April 2012.
The move is welcome news for corporate pension executives and other institutional investors because the corporate bond yields used to calculate discount rates are rising too.
And if yields — and interest rates overall — continue to rise, the number of corporate defined benefit plans transferring pension risk by buying group annuity contracts to cover future benefit obligations or making lump sum distributions from the plan could also increase, insiders say.
“Discount rates, which are based on corporate and not Treasury rates, are up. This means you are dividing by higher a number, which is good,” said Matthew E. Stroud, head of strategy and portfolio construction in the New York office of Towers Watson Investment Services Inc.
“Pension fund financial health ... would be stronger,” he said. “Assets up and liabilities down a little bit puts pension plans in a stronger position, all else being equal.”
Sean Brennan, principal in the financial strategy group, Mercer, New York, noted that liabilities have not dropped as much lately as they typically would have during a recovery. Often, when interest rates rise, liabilities will go down, he said.
“Liabilities have come down some; however, since credit spreads tightened, they didn't come down as much,” he said. “Treasuries and credit spreads have been partially offsetting each other recently in terms of corporate discount rates.”
Since the end of 2012, Treasury yields rose more than spreads tightened, Mr. Brennan said.
Indeed, in 2012, liabilities of corporate defined benefit plans rose 10% because interest rates fell, even though returns on assets for the year were 12.86%, according to data from Norwalk, Conn.-based consulting firm Rocaton Investment Advisors.