Implementing LDI Without the Long Duration

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Implementing LDI Without the Long Duration

Andrew Catalan, CFA

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

Executive Summary

As more U.S. plan sponsors weigh the costs and benefits of de-risking their pension liabilities with liability-driven (LDI) solutions, we are often asked if there are in fact enough long corporate bonds to satisfy current or potential future demand from defined benefit (DB) plans, especially in the event of a quick rise in interest rates. The following analysis seeks to answer that question from a number of different angles. First we measure the existing stock of long corporate bonds (LCBs) and then estimate potential demand from various sources in order to assess whether demand could be satisfied through market liquidity. While we can only estimate some of the variables in the calculations that are based on our own assumptions, we have a high degree of confidence in our conclusion that we could indeed reach a situation where the demand for long corporate bonds outstrips the supply. Given that possibility, plan sponsors can establish a long corporate strategy now that would reduce the capital loss associated with a long duration position if rates rise and could potentially outperform a core bond strategy even if interest rates rise.

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