Revisiting the Term Premium Cost on Funded Status
An analysis of the term-risk premium, new ways to measure it, and how increasing interest-rate hedge ratios can impact expected funded status returns.
Fixed income markets contain a high proportion of investors whose goal of identifying the most attractive relative value is subverted by jurisdictional or self-imposed rules, regulations, and constraints, or is superseded by other non-economic objectives, such as accounting conventions. This, in turn, creates opportunities for total return, multi-sector fixed income investors willing to consider broad investment guidelines and greater degrees of portfolio management freedom. In this paper, we lay out: 1) The fixed income market segmentation we observe and the resultant high dispersion in risk-adjusted reward; 2) Principles for identifying relative value and pitfalls to avoid; 3) An outline of our portfolio construction approach for building multi-sector portfolios.
In this paper, Tom McCartan, FIA, CFA, Vice President, Liability-Driven Strategies discusses the key risks to a U.S. corporate pension plan's funded status--declining long-term interest rates, tightening long-dated corporate spreads, credit migration, and falling risk assets--and shares practical steps plan sponsors can take now to protect funding levels ahead of the next recession.
*Based on managing the Long Duration (Government/Credit Custom) Composite, from inception July 1, 1998 to the date it closed July 31, 2020.
**Based on managing the U.S. Long Duration Corporate Fixed Income Composite, from inception November 1, 2003 to the date it closed June 30, 2018.
Source: PGIM Fixed Income. Assets under management as of June 30, 2021. Excludes assets managed for proprietary and retail clients. Assets under management are based on company estimates and are subject to change.
Bloomberg Barclays U.S. Long Government/Credit Index covers USD-denominated and non-convertible, publicly issued U.S. Government or investment-grade securities that are fixed rate or step ups. Securities must have a maturity of 10 years or greater and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
Bloomberg Barclays U.S. Long Corporate Bond Index covers USD-denominated and non-convertible, publicly issued securities that are fixed-rate or step ups. Securities must have a maturity of 10 years and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
Bloomberg Barclays U.S. Long Credit Index is comprised of publicly issued U.S. corporate debt and specified foreign debentures and secured notes denominated in USD that have at least 10 years until final maturity and are rated investment-grade (Baa3/BBB-/BBB- or better) using the middle rating of Moody’s, S&P, and Fitch, respectively.
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