WEBVTT NOTE Created by CaptionSync from Automatic Sync Technologies www.automaticsync.com 00:00:01.176 --> 00:00:04.846 align:middle >> You're listening to All the Credit, a monthly podcast series brought to you 00:00:04.846 --> 00:00:09.416 align:middle by PGIM Fixed Income, an active, global, fixed income investment manager. 00:00:10.726 --> 00:00:14.556 align:middle >> Welcome to the podcast, I'm Brian Barnhurst, Global Head of Credit Research. 00:00:14.756 --> 00:00:18.906 align:middle Today's episode is the second in a series that will examine the evolution of credit markets. 00:00:19.056 --> 00:00:24.376 align:middle I'm very fortunate to be joined by Multi-Sector Portfolio Manager, Tom McCartan, who focuses on, 00:00:24.446 --> 00:00:27.206 align:middle and as in expert in, liability-driven strategies. 00:00:27.666 --> 00:00:28.836 align:middle >> Thanks Brian, glad to be here. 00:00:29.876 --> 00:00:34.776 align:middle >> A lesser discussed byproduct of the regime shift in interest rates from the ultra-low rates 00:00:34.776 --> 00:00:38.216 align:middle of the post-GFC era to today is considerably improved funded status 00:00:38.216 --> 00:00:40.186 align:middle for defined benefit pension plans. 00:00:40.316 --> 00:00:43.936 align:middle The impacts are twofold, higher discount rates shrinking the liability side, 00:00:43.936 --> 00:00:47.756 align:middle and then higher nominal yields bolstering opportunities on the asset side. 00:00:48.136 --> 00:00:52.046 align:middle As recently as three years ago, the hundred largest U.S. defined benefit plans were 00:00:52.046 --> 00:00:57.166 align:middle collectively underfunded, today that funding ratio on average stands north of 100%. 00:00:57.536 --> 00:01:00.856 align:middle The paradigm shift in interest rates create a massive opportunity for sponsors 00:01:00.856 --> 00:01:05.256 align:middle to explore strategies to de-risk, even fully immunize their plan cash flows. 00:01:05.466 --> 00:01:09.666 align:middle Tom, help us make sense of the defined benefit landscape as it stands today. 00:01:10.676 --> 00:01:14.556 align:middle >> I think that's a really good framing, Brian, of the overall backdrop, 00:01:14.616 --> 00:01:17.956 align:middle and maybe I'll just kind of add a little bit more context in terms 00:01:17.956 --> 00:01:21.016 align:middle of where the corporate defined benefit plans are today. 00:01:21.256 --> 00:01:24.786 align:middle Clearly it's a spectrum of the circumstances that they find themselves in, 00:01:24.786 --> 00:01:29.056 align:middle but just for the simplicity, I think we can try and define three different larger, 00:01:29.056 --> 00:01:31.806 align:middle broader groupings of where the pension plans are at. 00:01:32.076 --> 00:01:35.366 align:middle As you said, their funded status is markedly improved. 00:01:35.696 --> 00:01:39.816 align:middle By and large they have mostly closed and frozen, 00:01:40.046 --> 00:01:44.676 align:middle and most of these old-style final salary pensions are now really not being offered 00:01:44.676 --> 00:01:46.016 align:middle by most corporations. 00:01:46.016 --> 00:01:49.146 align:middle And so, as broad groupings, you can really divide it into three, 00:01:49.716 --> 00:01:54.146 align:middle the first set of plan sponsors are really thinking about getting out of the pension game. 00:01:54.146 --> 00:01:57.106 align:middle Their pensions [inaudible], let's try and transfer 00:01:57.106 --> 00:01:59.296 align:middle and move the liabilities over to insurers. 00:01:59.296 --> 00:02:04.166 align:middle So, they're really trying to exit the pension game, and then take the volatility and are risk 00:02:04.166 --> 00:02:07.576 align:middle from their balance sheets and move it over into the insurance world. 00:02:07.616 --> 00:02:12.306 align:middle So, they're either doing that piecemeal through sequential set of transactions, 00:02:12.306 --> 00:02:16.006 align:middle parsing out the liability into different tranches and selling those off, 00:02:16.006 --> 00:02:20.446 align:middle or they are doing it in a whole scale termination, but ultimately for most 00:02:20.446 --> 00:02:22.776 align:middle of that grouping that's saying pensions [inaudible], 00:02:22.776 --> 00:02:25.956 align:middle that kind of termination is the end goal for a lot of those. 00:02:26.356 --> 00:02:30.426 align:middle The second broad grouping of plan sponsors is, those plan sponsors 00:02:30.426 --> 00:02:35.676 align:middle that also want the de-risking benefits on their balance sheets of the pension 00:02:35.676 --> 00:02:39.956 align:middle to take away the volatility on the balance sheets, take away the uncertainty 00:02:39.956 --> 00:02:43.976 align:middle around contributions, and impacts on their earnings, et cetera. 00:02:44.096 --> 00:02:49.476 align:middle But they're happy to keep the liability on balance sheets and run it down over time 00:02:49.476 --> 00:02:51.146 align:middle and pay the liabilities over time. 00:02:51.406 --> 00:02:54.776 align:middle But they want to do so in a very de-risked style asset allocation, 00:02:55.056 --> 00:02:57.566 align:middle which is going to clearly be very fixed income heavy. 00:02:57.696 --> 00:03:01.846 align:middle So they're really kind of focusing on managing down and reducing their surplus volatility. 00:03:02.326 --> 00:03:05.816 align:middle And then the third, maybe the most heterogeneous grouping, it's going to have a lot 00:03:05.816 --> 00:03:09.386 align:middle of different plan sponsors with different circumstances, but they're more thinking 00:03:09.386 --> 00:03:14.196 align:middle about maybe earning more return, growing their surplus, growing their level of assets relative 00:03:14.196 --> 00:03:18.806 align:middle to the liabilities, either because the plan is still open and accepting new members, 00:03:18.866 --> 00:03:22.286 align:middle or it could be closed, but they're still accruing new service accrual 00:03:22.286 --> 00:03:23.806 align:middle for existing participants. 00:03:23.986 --> 00:03:27.506 align:middle Or they have a cash balance liability that could be still accruing. 00:03:27.696 --> 00:03:30.946 align:middle Or they're in deficit and they still need to grow their assets 00:03:30.946 --> 00:03:34.406 align:middle and they don't necessarily want to close the funding gap with contributions. 00:03:34.496 --> 00:03:38.486 align:middle Or even, as we've seen in some kind of recent, more public examples of large sponsors, 00:03:38.546 --> 00:03:42.556 align:middle they have a lot of surplus but they want to try and use that surplus for other means 00:03:42.586 --> 00:03:45.906 align:middle within the plan and for providing other benefits for participants. 00:03:45.906 --> 00:03:49.226 align:middle So, clearly it's a spectrum, but those are kind of the three broad groupings. 00:03:49.916 --> 00:03:55.906 align:middle >> And as you think through different plan types and potentially different desired outcomes, 00:03:55.986 --> 00:04:02.596 align:middle help us parse through sort of the waterfall of navigating available de-risking strategies 00:04:02.686 --> 00:04:07.006 align:middle and how you think about, from the plan standpoint, timing, execution, 00:04:07.006 --> 00:04:09.646 align:middle and the considerations around these factors. 00:04:10.256 --> 00:04:13.306 align:middle >> Yeah, if we focus in on those three different groups and then think 00:04:13.306 --> 00:04:17.106 align:middle about what they're all doing differently, the first group is very focused 00:04:17.106 --> 00:04:21.096 align:middle on this insurance solution, so naturally what they're going to try and do 00:04:21.096 --> 00:04:24.576 align:middle and what they are trying to do, is move their asset allocation close 00:04:24.576 --> 00:04:29.526 align:middle to a portfolio that's going to be desirable from an insurance company standpoint. 00:04:29.526 --> 00:04:34.556 align:middle That an insurance company would like to receive as part of a transaction, and therefore not have 00:04:34.556 --> 00:04:38.396 align:middle to go out into the markets and create transaction costs to move 00:04:38.396 --> 00:04:39.986 align:middle to a portfolio that they would want. 00:04:39.986 --> 00:04:42.306 align:middle And this is going to enhance or improve the premium 00:04:42.356 --> 00:04:45.746 align:middle that the plan sponsor will get from the insurance market. 00:04:45.746 --> 00:04:49.366 align:middle So they're really trying to push their asset allocation close to what insurers want. 00:04:49.726 --> 00:04:52.446 align:middle That's not one generic asset allocation 00:04:52.446 --> 00:04:56.716 align:middle because all insurers have different preferences around which assets they prefer. 00:04:56.716 --> 00:05:01.576 align:middle But generically it's like create a portfolio that's a little bit more insurance friendly, 00:05:01.616 --> 00:05:02.776 align:middle or insurance attractive. 00:05:03.296 --> 00:05:08.096 align:middle The second grouping, that grouping that's going to hold the liability on balance sheet but try 00:05:08.096 --> 00:05:12.356 align:middle and really reduce the funded status volatility, is necessarily going 00:05:12.356 --> 00:05:15.806 align:middle to have a very fixed income heavy asset allocation. 00:05:15.926 --> 00:05:20.996 align:middle The liabilities are all valued with double-A bond yields, and so they're going 00:05:20.996 --> 00:05:26.196 align:middle to be building a big portfolio of bonds that's going to try and hedge as closely 00:05:26.196 --> 00:05:28.426 align:middle as possible, the risk of the liability. 00:05:28.786 --> 00:05:31.296 align:middle And then the approaches within that are going to be varied. 00:05:31.576 --> 00:05:34.696 align:middle Some or going to very strictly hedge the accounting liability, 00:05:34.696 --> 00:05:38.856 align:middle which is all double-A corporate bonds, and then some or going to take a bit more 00:05:38.856 --> 00:05:44.516 align:middle of a broader approach and look for a portfolio that's got a kind of broader array of sectors 00:05:44.516 --> 00:05:48.516 align:middle across the fixed income and credit markets included within that asset allocation, 00:05:48.546 --> 00:05:53.126 align:middle thereby taking a little bit more risk to the accounting liability in order 00:05:53.126 --> 00:05:55.296 align:middle to have a little bit more attractive portfolio. 00:05:55.726 --> 00:05:59.516 align:middle And then the third group, again, mentioning that just with the precursor 00:05:59.516 --> 00:06:03.666 align:middle that it's a little bit more of a heterogeneous group, dependent on where they are in terms 00:06:03.666 --> 00:06:05.966 align:middle of funded status, are they very underfunded? 00:06:06.056 --> 00:06:07.346 align:middle Are they very overfunded? 00:06:07.346 --> 00:06:11.616 align:middle There's going to be a whole array of different approaches within that bucket that's going 00:06:11.616 --> 00:06:15.926 align:middle to include growth assets and other assets that can be outside of bonds. 00:06:15.956 --> 00:06:19.656 align:middle But they're still likely going to be trying to reduce a lot 00:06:19.656 --> 00:06:22.386 align:middle of their less well-compensated liability risk. 00:06:22.386 --> 00:06:25.436 align:middle So hedging as much of their interest rate risk as possible. 00:06:25.496 --> 00:06:29.926 align:middle And a lot of the principles around trying to optimize or improve the risk adjusted return 00:06:29.926 --> 00:06:32.566 align:middle of their overall portfolio is going to apply for that group. 00:06:33.276 --> 00:06:35.646 align:middle >> Super helpful, and then I want to talk about asset allocation, 00:06:35.646 --> 00:06:40.726 align:middle but before we get there I'm curious, with the change in interest rate backdrop when we talked 00:06:40.726 --> 00:06:46.806 align:middle about the impacts on both liability and the asset side, is there a groundswell of activity 00:06:46.806 --> 00:06:50.526 align:middle in the LDI space, where we in sort of the cadence 00:06:50.526 --> 00:06:53.976 align:middle of attention on potentially de-risking plans? 00:06:54.506 --> 00:06:58.906 align:middle >> I think it's a great point, because there's clearly a lot of activity 00:06:58.906 --> 00:07:02.286 align:middle within plans we mentioned in those three groups, 00:07:02.366 --> 00:07:07.016 align:middle but then we should also mention two other groupings of different types of pension plans 00:07:07.016 --> 00:07:10.986 align:middle where there is also a kind of building level of activity as well. 00:07:11.426 --> 00:07:15.426 align:middle The first is the multi-employer, or Taft-Hartley plans, 00:07:15.466 --> 00:07:20.336 align:middle whereby through the American Rescue Plan Act, there was pretty sizeable contribution 00:07:20.336 --> 00:07:24.536 align:middle into those plans to help them improve their funding, which really picked up the funded level 00:07:24.536 --> 00:07:27.226 align:middle of a lot of those plans, but there were certain conditions 00:07:27.226 --> 00:07:32.936 align:middle around how they could invest those assets, which were a lot more akin to certain LDI principles 00:07:32.936 --> 00:07:37.626 align:middle of being focused on fixed income, and focused on the duration of their liabilities in terms 00:07:37.626 --> 00:07:38.936 align:middle of how they invested those assets. 00:07:39.476 --> 00:07:44.016 align:middle >> You're referring to, I think, an $80 billion cash injection tucked 00:07:44.016 --> 00:07:46.306 align:middle into the American Rescue Act during the COVID era. 00:07:46.986 --> 00:07:47.836 align:middle >> That's correct. 00:07:47.836 --> 00:07:51.056 align:middle That's correct, and it really changed the paradigm 00:07:51.056 --> 00:07:56.716 align:middle for those plans whereby Taft-Hartley plans and public plans really hadn't been 00:07:56.716 --> 00:08:01.176 align:middle in an LDI paradigm for a long period of time, because of differences 00:08:01.176 --> 00:08:03.216 align:middle in how they account for their liabilities. 00:08:03.216 --> 00:08:05.896 align:middle They don't use interest rates to value their liabilities, 00:08:06.016 --> 00:08:08.046 align:middle they use an expected return on assets. 00:08:08.086 --> 00:08:12.796 align:middle So as interest rates fluctuate, it doesn't change the value of their liabilities, 00:08:12.876 --> 00:08:17.846 align:middle so they didn't feel it necessary to try and hedge that risk by buying long-duration bonds. 00:08:18.056 --> 00:08:23.056 align:middle But the American Rescue Plan Act contributions that you refer to had some strings attached. 00:08:23.186 --> 00:08:28.376 align:middle And some of those strings were to invest with more LDI principles, more bonds, 00:08:28.376 --> 00:08:33.656 align:middle more liability matching for those extra funds that were put in to get them better funded, 00:08:33.656 --> 00:08:36.066 align:middle and so the strings attached were to try and make sure 00:08:36.066 --> 00:08:38.526 align:middle that they don't get underfunded again in the future. 00:08:39.036 --> 00:08:42.806 align:middle Likewise on the public plan space, another set of pension plans that, 00:08:42.806 --> 00:08:45.566 align:middle because of the accounting, haven't had the incentive to do LDI, 00:08:45.566 --> 00:08:50.426 align:middle but there are changes afoot, and there is transition happening in public plans now, 00:08:50.426 --> 00:08:54.476 align:middle where certain states are moving more towards a 401k or DC model, 00:08:54.536 --> 00:09:00.676 align:middle trying to get new employees auto-enrolled into more self-discretionary 401k-style pensions. 00:09:00.726 --> 00:09:06.556 align:middle Which then necessarily makes the old style DB pensions more of a legacy pension. 00:09:06.556 --> 00:09:11.986 align:middle And much, much further down the line, those type of states could go through the same transition 00:09:11.986 --> 00:09:16.726 align:middle that corporation DB has gone through, whereby those final salary pensions become more 00:09:16.726 --> 00:09:19.016 align:middle of a legacy style balance sheet item. 00:09:19.136 --> 00:09:23.656 align:middle And because of that legacy nature pushes them to do more de-risking and try 00:09:23.656 --> 00:09:28.556 align:middle and reduce the volatility associated with those liabilities by better matching the liabilities. 00:09:29.226 --> 00:09:33.356 align:middle >> What's really interesting to me is at the same time as we've had this paradigm shift 00:09:33.356 --> 00:09:38.056 align:middle in plan funded status to position, let's say the industry for lack of a better work, 00:09:38.056 --> 00:09:41.146 align:middle to think about de-risking strategy, or to be in a better position 00:09:41.146 --> 00:09:46.986 align:middle to explore de-risking strategies, it's coincided with an evolution of investment approach 00:09:46.986 --> 00:09:49.586 align:middle on the asset management side, which I think is really interesting. 00:09:49.586 --> 00:09:52.206 align:middle So you have sort of a lot of forces converging. 00:09:52.446 --> 00:10:00.376 align:middle Once plan sponsors make a decision to pursue LDI strategies, help us think through the evolution 00:10:00.436 --> 00:10:03.976 align:middle in solutioning for those strategies and then obviously we want to talk about our approach. 00:10:04.986 --> 00:10:07.716 align:middle >> Yeah, and it all starts from where you began the podcast, 00:10:07.716 --> 00:10:10.556 align:middle which is that yields are higher now, a lot more so, 00:10:10.676 --> 00:10:14.116 align:middle that's improved funded levels for a lot of different plans. 00:10:14.116 --> 00:10:19.056 align:middle But it's also for plans that have kind of fixed levels of target return, 00:10:19.126 --> 00:10:24.836 align:middle like 7 or 8% return bogey, it's brought bonds much closer to those levels 00:10:24.836 --> 00:10:29.096 align:middle and allowed more plans to think about higher allocations to fixed income within those. 00:10:29.446 --> 00:10:33.456 align:middle Within the corporate defined benefit plan space, I think there's two schools of thought 00:10:33.456 --> 00:10:36.686 align:middle of how you try and go about building a de-risking solution. 00:10:36.836 --> 00:10:41.856 align:middle There is a more traditional approach where you really do stick to try and buy the bonds 00:10:41.856 --> 00:10:45.926 align:middle that the liabilities are discounted with, so that's really double-A long-dated bonds. 00:10:46.066 --> 00:10:47.556 align:middle And then there's another school 00:10:47.556 --> 00:10:50.936 align:middle of thought whereby you can get a little bit better relative value 00:10:50.936 --> 00:10:55.766 align:middle by diversifying the portfolio a little bit outside of that single sector. 00:10:56.606 --> 00:11:00.606 align:middle >> I feel like for a very long period of time, basically the home asset class 00:11:00.606 --> 00:11:05.806 align:middle for LDI was high quality corporates, and I think we're both on the same page that long, 00:11:05.806 --> 00:11:08.976 align:middle high-quality corporates are arguably structurally rich, 00:11:09.036 --> 00:11:12.936 align:middle and non-dynamic from a portfolio construction standpoint. 00:11:12.936 --> 00:11:16.776 align:middle And maybe that's a great segue into your core role on the team you sit on, 00:11:16.806 --> 00:11:20.486 align:middle the Multi-Sector Portfolio Management Team, which I think is sort of a good moniker 00:11:20.486 --> 00:11:23.546 align:middle for thinking about our portfolio construction approach 00:11:23.546 --> 00:11:26.276 align:middle and solutioning approach to LDI strategies. 00:11:26.896 --> 00:11:32.586 align:middle >> Yeah, and it may have even been that that accounting approach that dictated 00:11:32.586 --> 00:11:38.046 align:middle to all pension plans, from the '80s onwards, that they had to value their liabilities 00:11:38.046 --> 00:11:43.666 align:middle with these bonds that created a huge amount of trillions of dollars in effect of captive demand 00:11:43.666 --> 00:11:46.746 align:middle that were effectively required to buy these bonds in order to hedge them. 00:11:46.806 --> 00:11:50.006 align:middle A little bit of that structural richness that you refer to. 00:11:50.306 --> 00:11:54.396 align:middle But we do think that it then creates an opportunity for plans 00:11:54.396 --> 00:11:59.016 align:middle to take a little bit more risk, a little bit more tracking error to that accounting liability 00:11:59.016 --> 00:12:05.056 align:middle by including some credit sectors that are not necessarily those long, high-quality bonds 00:12:05.056 --> 00:12:09.036 align:middle within the overall portfolio construction, whether this is corporate bonds 00:12:09.036 --> 00:12:13.956 align:middle of different qualities and maturities, whether it is below investment grade bonds, 00:12:13.996 --> 00:12:19.746 align:middle securitized credit, or credit derivatives, there is relatively good relative value 00:12:19.866 --> 00:12:24.006 align:middle for including some of those sectors if the portfolio construction is thoughtful enough 00:12:24.006 --> 00:12:25.876 align:middle of how to manage the different risks. 00:12:25.956 --> 00:12:29.956 align:middle Some of them can be relatively attractive versus those long, double-A bonds. 00:12:30.976 --> 00:12:34.636 align:middle >> The legacy portfolio construct is really focused on corporates. 00:12:34.636 --> 00:12:38.606 align:middle We've been really thoughtful about bringing structured product into the fold. 00:12:38.926 --> 00:12:43.516 align:middle How do you think about incorporating structured products, a little shorter in duration, 00:12:43.516 --> 00:12:46.296 align:middle typically floating rate, into the asset allocation 00:12:46.346 --> 00:12:49.616 align:middle when you're building LDI solutions alongside corporates? 00:12:50.546 --> 00:12:53.916 align:middle >> In general we like the asset class in securitized credit. 00:12:53.916 --> 00:12:58.256 align:middle And for the asset allocation framework that I outlined, where you can think 00:12:58.256 --> 00:13:02.726 align:middle about diversifying outside of long-dated corporates, it is one of the asset classes 00:13:02.726 --> 00:13:06.416 align:middle that we include within that framework and we do tend to have allocations to it. 00:13:06.746 --> 00:13:12.676 align:middle Certainly in today's market environment, with higher levels of spreads, flatter spread curves, 00:13:12.676 --> 00:13:17.876 align:middle asset classes which give you more risk remote, higher levels of carry that are sitting 00:13:17.876 --> 00:13:20.906 align:middle on the front end of the spread curves, seem attractive to us. 00:13:21.146 --> 00:13:24.746 align:middle Some of the things you have to think about with the asset class is a lot of it is floating rate. 00:13:25.006 --> 00:13:29.536 align:middle That's going to necessitate using interest rate derivatives to hedge back to the longer duration 00:13:29.536 --> 00:13:32.106 align:middle of the liability, so liquidity is key. 00:13:32.176 --> 00:13:36.716 align:middle Can you sell some of those assets to generate collateral for your collateral needs? 00:13:36.896 --> 00:13:40.656 align:middle Are there other securities in the portfolio that you can use for collateral purposes? 00:13:40.866 --> 00:13:43.186 align:middle So you're going to keep some Treasuries or cash in there? 00:13:43.186 --> 00:13:47.976 align:middle But by and large, we do like the risk remote carry relative to corporate bonds. 00:13:48.796 --> 00:13:52.236 align:middle >> And then relatedly, we recently did an episode on ABF. 00:13:52.346 --> 00:13:57.196 align:middle Sort of the topic dujour in markets right now, although maybe being overshadowed, 00:13:57.196 --> 00:14:01.146 align:middle hopefully for the short-time by tariffs, but how do you think about incorporation 00:14:01.146 --> 00:14:04.386 align:middle of private assets into LDI strategies. 00:14:04.386 --> 00:14:07.366 align:middle I know there's a myriad of considerations, but would be interested in your perspective. 00:14:08.146 --> 00:14:12.446 align:middle >> Yeah, I think the same comments that I made about including securitized assets 00:14:12.446 --> 00:14:15.806 align:middle within that multi-sector LDI framework apply. 00:14:15.916 --> 00:14:20.206 align:middle But just with the additional caveat of now you're further sacrificing liquidity. 00:14:20.616 --> 00:14:25.186 align:middle For the sacrifice I think you need that additional compensation of spread for some 00:14:25.186 --> 00:14:27.106 align:middle of those asset classes to be included. 00:14:27.106 --> 00:14:30.446 align:middle So, I think that's going to be what plan sponsors are going to be focusing 00:14:30.446 --> 00:14:34.216 align:middle on is the additional spread, I guess enough to compensate 00:14:34.216 --> 00:14:36.136 align:middle for the additional sacrifice in liquidity. 00:14:36.616 --> 00:14:41.476 align:middle If you're running that type of multi-sector asset allocation that's also supported 00:14:41.476 --> 00:14:46.606 align:middle by derivatives, the movements in interest rates is going to require the asset allocation 00:14:46.606 --> 00:14:50.886 align:middle to be rebalanced as different sectors have got different durations and are going to change 00:14:50.886 --> 00:14:54.156 align:middle in value and move you away from your strategic asset allocation. 00:14:54.446 --> 00:14:56.256 align:middle Rebalancing is going to be important. 00:14:56.256 --> 00:14:58.216 align:middle And then funding collateral is going to be important. 00:14:58.216 --> 00:15:01.896 align:middle So for private assets, you're going to sacrifice a little bit of those abilities, 00:15:02.156 --> 00:15:06.966 align:middle you definitely need that additional compensation but it does fit within the overall framework 00:15:06.966 --> 00:15:11.236 align:middle of thinking about that the LDI portfolio doesn't necessarily need 00:15:11.236 --> 00:15:13.976 align:middle to be all long, double-A corporate bonds. 00:15:14.686 --> 00:15:17.976 align:middle >> And, since you touched on it, one of the things I wanted to get your perspective 00:15:17.976 --> 00:15:22.406 align:middle on was the way in which you employ derivatives as an enhancement 00:15:22.456 --> 00:15:25.706 align:middle to cash strategies when constructing solutions. 00:15:26.346 --> 00:15:28.596 align:middle >> Yeah, I think it's really important for us 00:15:28.596 --> 00:15:32.286 align:middle to hedge the interest rate risk pretty closely of the liability. 00:15:32.556 --> 00:15:38.576 align:middle Interest rates are not as quickly mean reverting as spreads are in certain cases. 00:15:38.806 --> 00:15:43.016 align:middle And so, while we're more happy to take on spread reinvestment risk 00:15:43.066 --> 00:15:45.906 align:middle by being positioned somewhat shorter on the credit curves, 00:15:45.986 --> 00:15:48.726 align:middle that doesn't necessarily hold within interest rates as well. 00:15:48.996 --> 00:15:53.696 align:middle So we're typically more trying to hedge out all of our E-rate risk in interest rate space, 00:15:53.696 --> 00:15:58.556 align:middle and having a toolkit that has got various different interest rate products in there, 00:15:58.556 --> 00:16:03.786 align:middle whether it's swaps or Treasury futures or strips, is important for being able to implement 00:16:03.786 --> 00:16:08.126 align:middle that multi-sector LDI portfolio construction, which may have shorter duration 00:16:08.126 --> 00:16:10.116 align:middle or floating rate credit asset classes in there. 00:16:10.116 --> 00:16:16.756 align:middle >> I think the other potential use case is for large transactions 00:16:16.756 --> 00:16:21.876 align:middle where there's an expediency required, a threshold has been met, and the sponsor is ready 00:16:21.876 --> 00:16:26.626 align:middle to action, derivatives can help us move quickly at scale whilst we build 00:16:26.626 --> 00:16:28.866 align:middle out a longer-term cash allocation. 00:16:29.446 --> 00:16:36.356 align:middle Relatedly, how do you think about plan size and the match between solution types and size? 00:16:36.936 --> 00:16:41.466 align:middle >> So, everything we've talked about thus far today is agnostic of size. 00:16:41.526 --> 00:16:45.426 align:middle And both smaller plans and larger plans are going to be trying 00:16:45.426 --> 00:16:47.776 align:middle to implement some of what we've talked about. 00:16:47.776 --> 00:16:53.176 align:middle But it is true that at a certain point of size, separate accounts can start 00:16:53.176 --> 00:16:58.476 align:middle to become less practical for certain plans, and so those smaller plans are still trying 00:16:58.476 --> 00:17:02.276 align:middle to implement some of the ideas we've been talking about and so one 00:17:02.276 --> 00:17:04.856 align:middle of the things we've been doing recently in working with some of them on, 00:17:04.856 --> 00:17:09.016 align:middle is how to blend more co-mingled strategies in order to achieve some 00:17:09.016 --> 00:17:11.186 align:middle of the same portfolio construction results. 00:17:11.386 --> 00:17:15.916 align:middle And so, that's going to really help some smaller plans try and still take on some 00:17:15.916 --> 00:17:20.896 align:middle of these multi-sector LDI philosophies, but you need scale across a number 00:17:20.896 --> 00:17:23.266 align:middle of different LDI type co-mingled vehicles. 00:17:24.186 --> 00:17:27.506 align:middle >> Thanks Tom, it's certainly a really neat time in the LDI space, 00:17:27.506 --> 00:17:29.976 align:middle which is probably not something that could have always been said. 00:17:30.056 --> 00:17:36.156 align:middle The interest rate shift has been a shot in the arm for plan liabilities coupled 00:17:36.156 --> 00:17:39.506 align:middle with cash injections from the American Retirement Act, which we talked about, 00:17:39.556 --> 00:17:43.266 align:middle has bolstered funded status and has plan sponsors thinking 00:17:43.266 --> 00:17:45.366 align:middle about solutions for de-risking. 00:17:45.366 --> 00:17:50.206 align:middle At the same time that change in nominal interest rate has really created an environment 00:17:50.206 --> 00:17:54.306 align:middle where assets can earn a pretty attractive rate of return, 00:17:54.396 --> 00:17:59.716 align:middle the sum total of which makes it a really compelling time to think about LDI solutions. 00:17:59.946 --> 00:18:01.066 align:middle Thanks again for your time. 00:18:01.066 --> 00:18:02.536 align:middle Always a great conversation. 00:18:02.786 --> 00:18:07.016 align:middle If you'd like more thought leadership from PGIM Fixed Income, including detailed work 00:18:07.016 --> 00:18:11.726 align:middle on LDI related topics, please check us out on pgimfixedincome.com. 00:18:13.236 --> 00:18:14.656 align:middle >> We hope you enjoyed today's podcast. 00:18:15.236 --> 00:18:18.136 align:middle Subscribe to keep up with the latest episodes of All the Credit. 00:18:18.326 --> 00:18:21.846 align:middle For more insights and thought leadership, visit pgimfixedincome.com. 00:18:22.776 --> 00:18:25.236 align:middle This podcast is intended solely for professional investors' use. 00:18:25.236 --> 00:18:27.606 align:middle Past performance is not a guarantee of future results. 00:18:27.886 --> 00:18:30.406 align:middle All investments involve risk, including the loss of capital. 00:18:30.686 --> 00:18:34.256 align:middle This material is not for distribution to any recipient located in any jurisdiction 00:18:34.256 --> 00:18:35.886 align:middle where such distribution is unlawful. 00:18:36.126 --> 00:18:38.326 align:middle This podcast includes the views and opinions of the authors 00:18:38.326 --> 00:18:40.336 align:middle and may not reflect PGIM Fixed Income's views. 00:18:40.726 --> 00:18:43.046 align:middle PGIM and its related entities may make investment decisions 00:18:43.106 --> 00:18:45.016 align:middle that are inconsistent with the views expressed herein. 00:18:45.386 --> 00:18:48.226 align:middle This podcast should not be reproduced without PGIM's prior written consent. 00:18:48.616 --> 00:18:52.486 align:middle No liability is accepted for any direct, indirect, or consequential loss that may arise 00:18:52.556 --> 00:18:55.536 align:middle from the use of any information contained in or derived from this podcast. 00:18:55.976 --> 00:18:58.196 align:middle PGIM Fixed Income is not acting as your fiduciary. 00:18:58.396 --> 00:19:01.846 align:middle The contents are for informational purposes only, are based on information available 00:19:01.876 --> 00:19:03.536 align:middle when created, and are subject to change. 00:19:03.766 --> 00:19:06.146 align:middle It is not intended as investment, legal, or tax advice, 00:19:06.146 --> 00:19:08.466 align:middle and does not consider a recipient's financial objectives. 00:19:08.906 --> 00:19:12.126 align:middle PGIM Fixed Income is a business unit of PGIM, the global asset management business 00:19:12.126 --> 00:19:15.956 align:middle of Prudential Financial Inc., which is not affiliated in any manner with Prudential plc, 00:19:16.026 --> 00:19:19.186 align:middle incorporated in the United Kingdom, or with Prudential Assurance Company, 00:19:19.356 --> 00:19:22.396 align:middle a subsidiary of M&G plc, incorporated in the United Kingdom. 00:19:22.616 --> 00:19:23.826 align:middle Copyright 2025. 00:19:24.016 --> 00:19:26.596 align:middle The PGIM logos and the rock symbol are service marks of PGIM 00:19:26.596 --> 00:19:29.606 align:middle and its related entities registered in many jurisdictions worldwide.