The funded status spike for corporate pension plans the last three months has many plans looking for longer duration bonds to match liabilities and lock in funding improvements.
But capacity in the long bond market could become a large problem as so many plans hit funded status triggers in a relatively short period of time. Plans using a liability-driven investing strategy usually extend duration and purchase additional bonds as the funded status of the plan improves at incremental levels.
“I think there is a whole range of institutional and retail investors attracted to corporate bonds and in competition with corporate pension plans,” said Martin Jaugietis, New York-based managing director, LDI solutions, at Russell Investments.
The supply and demand concern largely depends on corporate bond issuances. Mr. Jaugietis said there are about $2.3 trillion in corporate pension liabilities. Over the last five years, investment-grade corporations sold an average of $131 billion in debt a year with maturities longer than 10 years, including $188 billion in 2012, about 18.6% of all debt sold last year. Long-maturity debt is currently 17.4% of the debt sold in 2013, according to data from Thomson Reuters.
Richard McEvoy, New York-based partner and leader of Mercer LLC's financial strategy group, said there will be “heightened demand over the next three to five years” as funding ratios improve. “It depends on how quickly trends emerge. If it happens faster (than anticipated), it's a fairly serious situation for plan sponsors.”
On top of a rising corporate demand, LDI could be the next “big thing” five years from now for public pension plans, said David Wilson, managing director, customized strategies, at Cutwater Asset Management. New regulations from the Governmental Accounting Standards Board on how unfunded liabilities are calculated at public plans are set to go into effect within the next couple of years. That might cause plans to increase risk initially with a lower overall funded status, but eventually will lead to strategies that lock in funding ratios as they improve, Mr. Wilson said.
In anticipation of a supply and demand crunch, Goldman Sachs Asset Management has started to hear from clients with glidepaths that are implementing time triggers, said Michael Moran, New York-based managing director and pension strategist. With a time trigger, Regardless of funded status, the plan will extend duration or add fixed income at a specific time for pricing and supply reasons, he said.
Mr. Moran said timing triggers are still more of the exception than the rule, but it is an idea he had never even heard about a year ago.
One option to get ahead of the game is to buy bonds now and retain equity exposure through the use of derivatives, Mr. McEvoy said. Other managers recommend interest rate swaps, futures and strips.
Plans can also sell swaptions and use the premiums for downside equity protection, said Gary Veerman, Chicago-based head of LDI strategy at Legal & General Investment Management America.
Mr. Veerman said there is about $1.4 trillion in long-duration credit and while there is not much of a problem getting those bonds now, there are “certainly supply and demand pressures on the horizon.”
“We're extremely busy with conversations,” Mr. Veerman said. “People realize the opportunity they missed twice in the last 10 years to get risk off the table.”
