LDI - A Statistical and Qualitative Review of Q3 2014 & Outlook for 2014

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Q3 2014 Commentary

Andrew Catalan, CFA

Andrew Catalan, CFA - Managing Director & Senior Portfolio Manager of the Liability Driven Investing group

Key Q3 Takeaways:

  • Rates remain anchored stubbornly low despite stronger economic data.
  • Negative excess returns thus far in 2014 for long corporate bonds are indicative of a slow rotation into long duration by plan sponsors.
  • Funded status has deteriorated for the typical pension plan since the beginning of the year given the rate rally.
  • Plan sponsors have several initiatives to mull such as the mortality assumption updates, HATFA, and partial liability settlements.
  • Looking forward, our base case is for higher rates, but slowing global growth can challenge that view and push off the Fed’s rate hikes.

“Let's go." "We can't." "Why not?" "We're waiting for Godot.”
― Samuel Beckett, Waiting for Godot


Samuel Becket’s absurdist play Waiting for Godot, first performed on January 5th, 1953, portrays two characters, Vladimir and Estragon, waiting time and again for someone named Godot to arrive. In the first act, Estragon attempts to leave, but Vladimir insists that the two of them cannot depart prior to Godot’s arrival. Such is a recurring conversation and theme throughout the play, with the two men unable to take any real action at all as Godot never comes. Even after making clear decisions to find shelter at night, the two never leave to find a suitable place to sleep at the end of each act. This paralysis seems very similar to the actions of plan sponsors with the implementation of LDI. Even after the decision is made to de-risk their investment strategies, the never-ending wait for the arrival of higher long term rates has hampered de-risking. The global rally in rates has taken most of the market by surprise given the nearing end of quantitative easing and the anticipation of rate hikes, both by the Federal Reserve (Fed). We will further discuss the frustrating wait for higher rates in December at the 2014 P&I Liability Driven Investing Conference.

The Q2 GDP figure of 4.6% gives us greater confidence in our forecast for U.S. growth of around 3.0% in the second half. We continue to believe that economic growth will moderate back toward its 2.5% trend rate in 2015, but that inflation will trend higher as a result of a tighter labor market and faster wage growth. These convictions imply a rise in rates, although escalating geopolitical risks and low sovereign yields in Europe and Japan may keep a lid on how far U.S. Treasury yields rise in the near term. Our Treasury fair value model, shown in Table 1, indicates that rates are far below where they should be based on fundamental factors alone. Other technical factors however are winning over in keeping rates low.


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