Pension Indicator Updated for November 30, 2018

Making Sense of Treasuries in LDI Portfolios

By: Grant Guyuron, Senior Managing Director, Clearstead

It wasn’t long ago that the thought of investing in treasuries for an underfunded pension plan seemed senseless.  Can you imagine buying a 10-year treasury bond at a sub 2% yield in a portfolio that was 80% funded vs. its liability and had an expected return on assets (EROA) of 7.5%?  A lot of investors might still question whether treasuries have value from a total return perspective, even as the yield hovers around 3% today.  However, if you are a pension plan sponsor with even a small allocation to liability driven investments, incorporating treasuries may be wise.

Yes, Treasuries are unlikely help you reach your EROA, but Treasuries could offer an excellent interest rate hedge and help to offset the “spread risk” associated with a portfolio of mostly return generating assets.  The issue that treasuries help to solve is the correlation issue that is generally true of long corporate bonds and equities.  Going back to 1988, the S&P 500 has a correlation to the Bloomberg Barclays Long A+ Credit Index of 0.20, whereas the correlation to the Bloomberg Barclays Long Treasury Index is -0.081.  In a distressed market such as 2008, the S&P 500 returned -37%, the Long Credit Index returned -0.2%, and the Long Treasury Index returned +24% .  In other words, combining an equity portfolio with a long credit portfolio can result in more spread risk than is intended.

In addition to being less correlated to equities, treasuries and treasury strips can be utilized to lengthen the duration of portfolio to better match the plan sponsor’s liability and improve the plan’s hedged ratio.  As the Plan’s funded status improves and the allocation to liability hedging assets increases relative to return generating assets, it is reasonable to assume that treasury exposure may be reduced as it is less necessary to offset reduced equity market risk.  So while the thought of investing in treasuries in isolation may seem lackluster or unnecessary, these securities remain a valuable tool for plan sponsors that are in the early stages of building LDI portfolios.

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Information provided in this article is general in nature, is provided for informational purposes only, and should not be construed as investment advice. Performance data represents past performance.  Past performance is not indicative of future results.

Year to Date Investment Mix 
Plan TypeAggressiveBalancedLDI LiteLDI
 Frozen (for several years) 4.7% 3.6% 0.9% -2.1%
 Recently Frozen 7.9% 6.7% 4.0% 0.9%
 Ongoing Traditional 11.5% 10.3% 7.5% 4.3%
 Cash Balance 5.5% 4.4% 1.7% -1.4%
Month-over-Month Investment Mix 
Plan TypeAggressiveBalancedLDI LiteLDI
 Frozen (for several years) 0.8% 0.6% 0.3% -0.1%
 Recently Frozen 0.7% 0.6% 0.3% -0.1%
 Ongoing Traditional 0.7% 0.6% 0.3% -0.1%
 Cash Balance 0.7% 0.6% 0.3% -0.1%
12-Month Change Investment Mix 
Plan TypeAggressiveBalancedLDI LiteLDI
 Frozen (for several years) 7.5% 6.5% 4.2% 1.5%
 Recently Frozen 9.9% 8.9% 6.5% 3.8%
 Ongoing Traditional
12.6% 11.6% 9.1% 6.3%
 Cash Balance 8.2% 7.2% 4.8% 2.1%

FrozenManyYears 11 30 18

RecentlyFrozen 11 30 18

Ongoing 11 30 18

CashBalance 11 30 18