Early Rationale for Bond Allocations: Vanilla Ice Cream!
Core holding to provide stable returns…flight to quality syndrome,
Board/Trustee “feel good, sleep at night”
Willing to live with lower returns because equities will outperform…always
count on double digit equity returns
Index holdings then forget about it…actually be paid to index so your
bonds could be leveraged
Willing to live with the duration mismatch of liabilities…RRB’s have helped
Liabilities in Canada…should own $ C bonds…home bias, we understand
domestic bonds even if we don’t understand our liabilities
No currency exposure on any foreign bond holdings…fully hedged…any bond
returns easily wiped out by currency swings
Implications for Pension Plans Investment risk was measured as volatility of returns, or relative to benchmarks not relative to liabilities Asset mix typically 60% stocks 40% bonds Not enough alpha. Too much volatility. Interest rates fell almost continuously since the 1980’s which increased PV of liabilities Stock markets outperformed in the 1990’s then did not meet assumed rates of return when the bubble burst while PV of liabilities grew faster Bond portfolios were short term , usually measured against a Universe Bond Index, so as rates rose, value of bond portfolios did not rise as much as PV of liabilities grew
More liability studies undertaken by consultants…liability
consultants showing up now with new technology
Plans/Boards/Trustees need education in the …...“ World of
Fixed Income “….especially markets outside Canada
More fixed income customization….replicating yield curves to
match duration of assets…LDI
More “packaged solutions” for the medium and smaller plans
Plans in Canada are finally reviewing their fixed income
allocations…looking to “ Core Plus “
What About Bonds? Universe courtesy of Mercer Investment Consulting. Calculations monthly in $CDN. Past performance is not indicative of future results.
What About Bonds? Greater opportunities globally Rates of Return(%) Expanded Global Opportunities Over 96% of Fixed Income Opportunities Range of 7.9% between top and bottom performers Global Fixed Income Universe courtesy of Evestment. Calculations quarterly in $US. Performance before fees for periods ended December 31, 2008
The DB Dilemma It’s real. It’s here! Time to “ de risk “? Fixed Income in Canada
Viewing portfolio construction through an “LDI lens” is a valuable process even if asset allocation is ultimately not changed.
No “one-size-fits-all” LDI solution exists.
Expect more diversity in asset strategy as plan sponsors incorporate unique circumstances, seek further diversification and embrace asset classes/strategies that offer high potential for active management.
For corporate plans, expect a gradual migration from intermediate duration to longer duration and increase in fixed income allocations
Envision derivative-based solutions to be more widely accepted as a standard tool to hedge liabilities and port alpha
Smaller plans and those seeking simplicity will migrate, at least initially, towards pooled funds
LDI affects all steps in the fiduciary process: assessing the existing position, strategic planning, implementation, and performance measurement