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Long Duration

INVESTMENT INSIGHTS  |  November 2016

Reflecting Plan Sponsor Risk Tolerance in Glide Path Design

Synchronize your risk tolerance and LDI glide path
  • What is the optimal way for a defined benefit plan to de-risk? This is one of the most challenging questions faced by plan sponsors.
  • To answer appropriately, a sponsor must first consider their risk tolerance and the objective factors influencing it — including the plan’s relative size, whether it’s open or closed, and business cyclicality.

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To contribute, or not? It's a big question for plan sponsors. Our experience working with sponsors suggests that it's typically optimal for them to make some contributions — especially from an after-tax perspective. What’s more, there’s good reason to think that the economics of making contributions will become still more compelling over the next few years. Underfunded plans will face a large and growing cash penalty for deferring contributions. Because the economics are swinging strongly in favor of making contributions, plan sponsors with bond market access may even have an incentive to borrow to fund the plan.

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INVESTMENT INSIGHTS  |  January 2016

What Should Plan Sponsors Do When Rates Rise? It Depends…

For a long time, a rise in interest rates has been discussed and expected. While the Federal Reserve has finally begun its move away from its near-zero interest rate policy and a further rise in rates may now seem imminent, the past few years have for some sponsors underscored the fact that “being early” can prove expensive. Plan sponsors who want to prepare for higher rates should not pick strategies that are too sensitive to the precise timing of a rise in rates.

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INVESTMENT INSIGHTS  |  January 2016

When Rates Rise, How Might Your LDI Strategy Fare?

The Federal Reserve has finally begun its move away from its near-zero interest rate policy, and many plan sponsors may expect interest rates to rise further. From an LDI perspective, what should you do if and when rates rise, and discount rates increase accordingly? This, it turns out, is a simple question with a far-from-simple answer. Interest rates can go up for a variety of reasons. The economic backdrops in which liability discount rates may rise can be surprisingly different and, consequently, so can the behavior of asset prices.

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Amid Low Bond Yields, Some Plan Sponsors Consider Delaying LDI Implementation Treasury Yields

Month-end yields from June 30, 2000, through June 30, 2015.
Source: Bloomberg.

Summary

  • Some plan sponsors are holding off implementing liability-driven investing (LDI), anticipating that the Federal Reserve will soon commence a rate hike cycle.
  • However, the intuition that rising short-term rates will result in greater valuation declines for long-duration credit compared to intermediate bonds may not be correct.
  • A consideration of the future trajectory of interest rates and the future shape of the yield curve suggests positive total return potential for long-duration credit over the next couple of years.

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DEFINED CONTRIBUTION INSIGHTS  |  September 2014

A Closer Look at the American Funds Target Date Retirement Series® 

Exhibit 3: American Funds (R-3) vs. Relevant Index

*Some indexes do not have histories sufficient for comparison to the lifetime of certain funds. See General Methodology section below for details.

In these videos, portfolio managers Jim Lovelace, Wesley Phoa and Brad Vogt discuss the American Funds Target Date Retirement Series.

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INVESTMENT INSIGHTS  |  September 2014  |  FEATURING Wesley K.-S. Phoa & E. Luke Farrell

Designing and Implementing a TE-Constrained LDI Strategy

Pension Plan Volatility*

Asset allocation can have a substantial impact on funded status volatility.

*From 2002 to 2012 based on asset class monthly index returns.

Core fixed income: Barclays U.S. Aggregate Index Equities: 70% S&P 500 and 30% MSCI EAFE Index. Long government credit: Barclays U.S. Long Government/Credit Index. Long credit: Barclays U.S. Long Credit Index.

Sources: Barclays, Capital Group.

A well-designed LDI program with tracking error constraints can help plan sponsors strike a balance between expected excess return and risk controls.

Liability-driven investing has changed over the past decade. Defined benefit plan sponsors have gradually moved from broad mandates with considerable latitude to more tightly designed and benchmark-aware mandates. In recent years, some plans have taken this a step further and stipulated explicit tracking error constraints for LDI mandates. In our view, setting tracking error targets makes sense for pension plans that have substantially reduced plan risk, or the mismatch of assets and liabilities, also referred to as funded status volatility. In addition to tracking error targets, plan sponsors will benefit from also paying close attention to investment guidelines such as credit quality.

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INVESTMENT INSIGHTS  |  April 2014  |  FEATURING David S. Lee

Rising Corporate Leverage and Spread Dispersion Create Bond Opportunities

Corporate Spreads Have Declined for Most of the Past Five Years

Option-adjusted U.S. investment-grade corporate spreads (3/31/2009–3/31/2014)

Source: Barclays Research.

Portfolio manager David Lee shares his thoughts on the changing market environment for corporate bond investing, and offers his outlook on some key opportunities and risks. Among other topics, David discusses his views on:
  • Mergers-and-acquisitions (M&A) activity and broader trends in corporate leverage
  • Relative value among banks and emerging markets corporates
  • Liquidity and transaction costs in today’s credit markets

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INVESTMENT INSIGHTS  |  September 2013

Adding Value in TE-Constrained LDI Mandates

As plan sponsors gain experience with liability driven investing and approach a higher funded status, many are focused on designing and implementing LDI mandates with greater risk control. The imposition of tracking error targets on these strategies has been an important step in this direction. Tracking error constraints allow plan sponsors to gain visibility and better control over the discrete sources of risk and excess return in actively-managed LDI mandates.

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INVESTMENT INSIGHTS  |  October 2012  |  FEATURING David S. Lee

Fixed-Income Portfolio Manager David Lee

The U.S. credit market has been a bright spot for investors this year as corporate bonds have staged a powerful rally. In this Q&A, corporate bond manager David Lee discusses his outlook for the market, sectors where he is finding value, his approach to long duration portfolios and how his view of the U.S. economy helps shape his investment strategy.

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INVESTMENT INSIGHTS  |  September 2012

New Pension Rules Shouldn’t Derail Long-Duration Strategies

Figure 1: Between 2004 and 2007, the 10-Year Treasury Yield Rose and the 25-Year Moving Average Fell

Source: Thomson Reuters Datastream
As of August 30, 2012

New federal pension rules that raise the discount rate applied to liabilities for contribution purposes have opened the debate on whether plan sponsors should delay implementation of asset-liability matching long-duration strategies. The new rules, which were included in the transportation bill that President Obama signed in July, may provide relief from the impact of the currently very low interest rates used to calculate liabilities for the purposes of determining minimum contributions under ERISA. Plan sponsors may be tempted to use this relief to reduce contributions and/or shorten duration in anticipation of higher interest rates. However, we believe that plan sponsors should think carefully before doing so, as relief from the law likely will be temporary and higher interest rates don’t necessarily undermine the long-term case for owning long-duration assets.

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INVESTMENT INSIGHTS  |  October 2011

Strategy in Depth: Long Duration With a Focus on Credit

Bond Management Can Add Value

Focus on bond management to maximize total returns

Source: Capital Group. For illustrative purposes only.

Implementing an effective long duration strategy has gained greater urgency for corporations as they begin to comply with the Pension Protection Act (PPA). The legislation, enacted in 2006, sets minimum funding standards for corporate defined benefit pension plans in the U.S.

Capital Group has managed a government/credit-plus long duration strategy for more than a decade. We recently introduced a new long duration strategy focused on credit partly to meet the need of clients who need a tighter match between assets and liabilities. The existing long duration government/credit strategy is wider in scope, investing in corporate bonds and government securities for greater flexibility, but with a looser match to liabilities. Both the credit and government/credit long duration strategies are also offered in “plus” variations, expanding the universe of investments to include global high-yield bonds. Capital’s long duration strategies focus primarily on cash fixed-income securities, using interest rate derivatives sparingly and primarily for yield curve management and duration positioning.

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Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses or the funds’ characteristics statement, which can be obtained from a financial professional or your relationship manager, and should be read carefully before investing. 

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice. 

Past results are not predictive of results in future periods.