LDI is similar to banks running a fully hedged book. When interest rates rise, the present value of pension plan liabilities fall. But of course when rates rise, many bond prices fall offsetting the liability gains. Conversely, when interest rates fall the present value of liabilities rise offset by a gain in bond prices. Ultimately it is expected that the desire for those running U.S. pension plans to match liabilities will encourage “de-risking,” moving away from equities into the fixed income realm. We have already seen evidence of this de-risking globally.4
Published by Morgan Stanley Research on October 8, 2013
For instance, in the United Kingdom, equity allocations have fallen from 68% to 39% over the last decade, and could ultimately fall as low as 10% for defined benefit plans.5
Published by Morgan Stanley Research on October 8, 2013
So the much discussed great rotation from fixed income into equities makes for nice headlines, but the actual numbers look to be far from reality as the demand for fixed income securities heats up globally, including here in the US.
Furthermore, on a yield front, the US looks attractive relative to the rest of the world. Our 10-year is yielding about the same as those sovereign bonds of the likes of Italy and Spain. Which would you believe is a more credit-worthy country? Our rates are more than double those of countries such as German and Japan.6
Fed policy, as well as supply and demand dynamics all pay into actual interest rates. As we look forward, demand for bonds and other fixed income asset classes is coming from both the retail and institutional investor and that demand is expected to accelerate as the trend of de-risking away from equities and into fixed income moves firmly into place. And we are already seeing a strong demand for bonds above and beyond the Fed. For instance, the bid-to-cover ratio for the longer-term bonds has been nearly 3:1 in 2014. So while the Fed may ultimately start gradually taking rates up over the next couple years, we expect the demand for Treasuries and other fixed income securities to remain strong, and even accelerate as demographics become more of a factor. We would expect that this, along with the economic headwinds and global dynamics, will constrain rates going forward.
1 Hamilton, Bruce, Matthew Kelley, Anil Sharma, Andrew Sheets, Anton Heese, and Matthey Hornbach. “Great Rotation? Probably Not,” Morgan Stanley Blue Paper, Global Asset Managers, October 8, 2013, p. 13.
2 Hamilton, Bruce, Matthew Kelley, Anil Sharma, Andrew Sheets, Anton Heese, and Matthey Hornbach. “Great Rotation? Probably Not,” Morgan Stanley Blue Paper, Global Asset Managers, October 8, 2013, p. 20.
3 Hamilton, Bruce, Matthew Kelley, Anil Sharma, Andrew Sheets, Anton Heese, and Matthey Hornbach. “Great Rotation? Probably Not,” Morgan Stanley Blue Paper, Global Asset Managers, October 8, 2013, p. 15.
4 Hamilton, Bruce, Matthew Kelley, Anil Sharma, Andrew Sheets, Anton Heese, and Matthey Hornbach. “Great Rotation? Probably Not,” Morgan Stanley Blue Paper, Global Asset Managers, October 8, 2013, p. 17.
5 Hamilton, Bruce, Matthew Kelley, Anil Sharma, Andrew Sheets, Anton Heese, and Matthey Hornbach. “Great Rotation? Probably Not,” Morgan Stanley Blue Paper, Global Asset Managers, October 8, 2013, p. 18.
6 Data sourced from Bloomberg, as of 8/1/14.
This article was written by Tim Gramatovich, CFA, CIO & Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD).