LDI Dead?

[WWSituation]

Originally Posted by Kenny

What do you want me to do about it?

If I had a good answer, I probably would not have left the field. I have no solution unless you are close to retirement, in which case I recommend just collecting the paycheck

[Mr. BoH]

Originally Posted by Kenshiro

What are you guys smoking? There's an easy and rather obvious way to hedge discounting using corporate bond rates. Invest in corporate bonds.

Ummmm.... no. There are lots of reasons, but I'll start with a quick quiz:

Q1: If the corporate bond interest rate is 6%, what is the expected return on corporate bonds (hint: not 6%), and how does it compare to the expected return on a liability valued at a corporate bond rate?

Q2: If my pension liability has a duration of 20, what corporate bonds with sufficient depth and liquidity exist to match duration? What about my liability cashflows in year 50? 75?


Maybe your point is that corporate bonds are a better hedge of liabilities than equities (duh). But liabilities discounted at a corporate bond rates are nowhere close to investable. Wouldn't it make more sense to have funding and accounting rules that would allow sponsors to take risk off the table if they chose to do so?

[SirVLCIV]

Originally Posted by mr coffee

Her equity position was lower than some, but she still took a nice hit (and apparently got a nice paycheck for her "risk management") from the equity position she took.

Find me an institutional investor who did not lose any money in 2008.

[Kenshiro]

Originally Posted by Mr. BoH

Ummmm.... no. There are lots of reasons, but I'll start with a quick quiz:

Q1: If the corporate bond interest rate is 6%, what is the expected return on corporate bonds (hint: not 6%), and how does it compare to the expected return on a liability valued at a corporate bond rate?

Q2: If my pension liability has a duration of 20, what corporate bonds with sufficient depth and liquidity exist to match duration? What about my liability cashflows in year 50? 75?


Maybe your point is that corporate bonds are a better hedge of liabilities than equities (duh). But liabilities discounted at a corporate bond rates are nowhere close to investable. Wouldn't it make more sense to have funding and accounting rules that would allow sponsors to take risk off the table if they chose to do so?

Q1. For accounting, you better be using the expected return, or you're doing it wrong. The funding number is a bit different, but at least it seems to be highly correlated. Are you using quoted yields or something? Ignoring default risk?

Q2. Again, for accounting, you should only be considering investable securities with sufficient depth and liquidity. For cash flows in later years, with no corporate bond equivalent, the rules are flexible enough that you can use anything reasonable.

It seems pretty clear to me that the accounting rules permit you to choose the methodology used to set your discount rate in such a way that you can exactly hedge your interest rate risk. Luckily, the funding rules are similar enough that a hedge of accounting liabilities will, most often, also provide a very good hedge of funding liabilities.

I won't say there aren't problems with the approach. I've argued for something closer to a risk free discount rate in the past, but I don't think the supposed inability to hedge the interest rate risk is a valid reason.

[WellThen]

Originally Posted by SirVLCIV

Find me an institutional investor who did not lose any money in 2008.

And aren't they responsible for blindly investing in companies that were worth nothing in the first place?

[SirVLCIV]

Originally Posted by WellThen

And aren't they responsible for blindly investing in companies that were worth nothing in the first place?

You could have invested in perfectly healthy companies and lost money in 2008. Though, if that were the case, you'd have a big chunk of it back in 2009.

[insert bragging for my >200% return year to date in the AO Investment Game]

However, again, pensions should not be in equities.

[Mr. BoH]

Originally Posted by Kenshiro

Q1. For accounting, you better be using the expected return, or you're doing it wrong. The funding number is a bit different, but at least it seems to be highly correlated. Are you using quoted yields or something? Ignoring default risk?

I think the vast majority of plans use the yield without any adjustment for default, downgrade, etc.

Originally Posted by Kenshiro

Q2. Again, for accounting, you should only be considering investable securities with sufficient depth and liquidity. For cash flows in later years, with no corporate bond equivalent, the rules are flexible enough that you can use anything reasonable.

My point is that "investable securities with sufficient depth and liquidity" don't exist past a duration of about 12. Using a "reasonable" equivalent for later years makes the math work out in a way that makes accountants happy, but "reasonable" <> "investable".

Originally Posted by Kenshiro

It seems pretty clear to me that the accounting rules permit you to choose the methodology used to set your discount rate in such a way that you can exactly hedge your interest rate risk.

If your point is that would be permitted to choose a discount rate based on the risk-free curve, then I agree with you. But the fact of the matter is that virtually nobody does this because it would put them at a competitive disadvantage (on an accounting basis) to companies using corporate bond rates.

If you are trying to argue that you can invest in corporate bonds to "exactly hedge your interest rate risk" that is just plain wrong.

Originally Posted by Kenshiro

I won't say there aren't problems with the approach. I've argued for something closer to a risk free discount rate in the past, but I don't think the supposed inability to hedge the interest rate risk is a valid reason.

Certainly investability is not the only (or even the biggest) reason to move to a risk-free curve. But it is a reason (in my opinion).

[sumif]

Wow.. This is one of the most interesting threads I have ever read. I want to switch from PnC into Pension!

[campbell]

http://www.dailyreckoning.com.au/pen...ks/2009/10/16/

Pension plans are selling stocks. Headline or footnote?

Recent history suggests this little news item should be a headline. Pension plans - like supertankers, but unlike politicians - take a lot of time to reverse direction. But once plan fiduciaries decide to proceed in a given direction - investment-wise - they typically continue down that path for years, if not decades.

This tendency provides the mother of all long-term indicators for the financial markets. Although pension plan fiduciaries tend to be VERY wrong at major, long-term turning points, they tend to be right - more or less - as markets transition from one extreme to the other.

Confused?

The principal is actually very simple: pension plans behave like long- term momentum investors. So they tend to buy into rising markets...until after those markets have peaked and begun a major decline. Conversely, fiduciaries tend to sell into falling markets until after those markets have bottomed out and begun a decisive uptrend.

In aggregate, therefore, pension fund fiduciaries tend to behave like novice investors - buying high and selling low. But since their momentum investing unfolds over such long timeframes, this group of investors tends to be very right during the middle of a big move - up or down - in any particular asset class.
....
Net-net, CalPERS is now a seller of equities...or at least not a buyer. Most of the other pension plans in the US (and in the rest of the world) will likely follow CalPERS' lead.

"Equity assets in the U.K. fell to 41 percent of holdings at the end of 2008, according to data compiled by New York-based Citigroup," Bloomberg News reports. "The last time British pension funds held so little in equities was in 1974..."

Meanwhile, Bloomberg continues, "Four of the world's seven largest pension funds...have cut their equity target allocations..." It's probably safe to assume, therefore, that "caution" is the new buzzword in the halls of most pension fund managers. So it seems highly unlikely that they will exhibit their former exuberance for equities any time soon.

Demographic trends, as well as caution, will prohibit aggressive equity allocations. In California, for example, the baby boomer retirement wave is just beginning, which means that CalPERS must begin favoring capital preservation over "long-term growth." Ditto most other pension funds on the planet.


"The number of people worldwide 65 and older may jump to 1.3 billion by 2040 from 506 million last year," Bloomberg reports. "Their proportion of the total population will double to 14 percent in the same period, according to a June report from the US Census Bureau."

"[Since] the heavy equity weightings of public pension funds in this great land of ours comprise not only the mother of all sentiment indicators, but also a monstrous overhang of stocks, what if the funds sell?" your editor wondered in his mid-2000 article. "No sane fiduciary would choose to sell stocks of course - not if he or she wished to retain a comfortably feathered nest. But demographic trend may force the hand...Probably, the looming overhang is nothing to worry about - right now. But when the overhang threatens to break loose, remember: you heard it hear first."

That moment may have arrived.

[campbell]

http://www.reuters.com/article/rbssF...45727420091021

LONDON, Oct 21 (Reuters) - Pension plans are likely to purchase more than 3 billion pounds of bulk annuities this year, eclipsing the historical trend of around 1 billion pounds a year, according to research from Mercer.

The global financial consultancy said the bulk annuity market has grown over the long term, despite the effects of the credit crisis on the ability of trustees and sponsoring employers to purchase bulk annuities.
....


With pension funds and life insurers under pressure to increase their capital solvency to fund the pension market, investments with the insurance markets are becoming more popular as a way to back legacy pension commitments. Mercer said it expects these markets to grow strongly in the future.

Are "bulk annuities" GICs?