High-Quality Securitized Products - An Optimal Diversifier for LDI Portfolios
- The glidepaths of many corporate pension plans have benefitted from a combination of favorable returns and contributions. Glidepath progress often means higher hedged ratios and higher fixed income allocations.
- Given the accounting standard of using AA corporates to value pension liabilities, pensions are incentivized to concentrate risk in high-quality investment grade corporate bonds as fixed income allocations grow.
- This approach potentially creates a large concentration of credit risk within investment grade corporates. Many plan sponsors are now implementing diversification strategies to dampen credit risk while still maintaining control of their funded status volatility.
- We believe that allocating to high-quality securitized products may reduce effects of credit-migration risk and enhance long-term risk-adjusted returns. These securities are optimal diversifiers that belong in the hedging portfolios of a corporate defined-benefit plan.
- This paper provides insight into why we believe high-quality securitized products fit within the asset allocation options of an LDI portfolio. We also identify the existing opportunity set and articulate how the excess return more than compensates for the increased tracking error in a plan’s funded status