Why Now May Be the Time to Increase LDI Exposure
Why Now May Be the Time to Increase LDI Exposure
Given attractive yields along with high funded ratios and moderate fixed income allocations by pension plans, now appears to be an opportune time for plans to consider increasing their LDI exposure. Darren Hewitson, CFA , Senior Portfolio Manager, discusses opportunities in long duration for pension and LDI investors.
Key Takeaways
- The recent rise in long-term yields has been driven by increased Treasury issuance and declining demand from major investor groups like central banks, commercial banks, and foreign investors.
- While credit spreads have been reasonably well-behaved and valuations are full, our team continues finding relative value opportunities within major sectors.
- SBH can help design customized LDI strategies to capitalize on today’s higher yields based on each client’s unique liabilities and circumstances.
Additional Resources:
Liability-Driven Investing Strategy
Taxable Fixed Income Strategies
The opinions expressed in this video are solely the opinions of Segall Bryant & Hamill or an unaffiliated third party. You should not treat any opinion in this video as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinions. The opinions expressed in this video are based upon information considered reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this video does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this video. For illustrative purposes only.
Investment Summit Fourth Quarter 2023
SEGALL BRYANT & HAMILL
• www.sbhic.com
Given attractive yields along with high funded ratios and moderate fixed income allocations by
pension plans, now appears to be an opportune time for plans to consider increasing their LDI
exposure.
Darren Hewitson, CFA, Senior Portfolio Manager,
discusses opportunities in long
duration for pension and LDI investors.
Dan McCormack:
Following the increases that we experienced in 2022, we have seen yields continue to move
higher across the Treasury curve over the last few months, particularly for longer duration securities. What do
you think drove us to this point and do you expect any major changes?
Darren Hewitson:
It has been about a year since we last had a discussion on a similar topic, which we did in the
wake of the U.K. pension crisis in 2022 which saw a big sell-
off in long
-term yields. It is interesting timing for a
couple of reasons. The first being that we have seen a move of similar magnitude in long duration Treasuries over
the last few months. And the other thing that’s timely is that we just had the Treasury's quarterly refunding
announcement. The reason I say that’s interesting is because this is one of the things that we think precipitated
the move over the last few months, that is, the prior refunding announcement that came out in August. We think
that caught investors off guard and started the move higher in yields and the steepening of the yield curve.
What does that mean? It’s more long duration Treasury debt coming to market or more debt issuance. When
thinking about a traditional supply
-demand-
type construct, it has been a supply shock to the market. We then
combine that with demand erosion, which is what we have seen over the last several quarters from three large
constituents of the market (central banks, commercial banks, and foreign investors) as illustrated in
Exhibit 1
.
Liability-
Driven Investing (LDI) Q&A
Investment Summit Fourth Quarter 2023
Why Now May Be the Time to Increase LDI Exposure
$(1.0)
$(0.5)
$-
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
$3.5
$4.0
$4.5
12/31/2019
12/31/2020
12/31/2021
12/31/2022
6/30/2023
$ Trillions
Total UST Supply
Fed/Banks/Foreign Combined UST Holdings
Exhibit 1: Major Holders Have Reduced UST Holdings by $845 Billion Despite Continued Issuance
Year to date change in UST supply and combined Fed/bank/foreign UST holdings. Data as of 6/30/23. Source: Bloomberg.
Investment Summit Fourth Quarter 2023
SEGALL BRYANT & HAMILL
• www.sbhic.com
Over the last decade or so, those three investor bases have comprised over 50% of the Treasury market at times.
That support has declined as those investor types have pulled back. If we go back to Economics 101 of supply
versus demand, there has been a supply shock and a reduction in demand. What does that do? All else equal,
that pushes prices down or, in the case of fixed income, it pushes yields up, which is what we have seen.
We have seen a more resilient economy than some people expected over the last few quarters. We continue to
see volatility from a number of factors (geopolitical, for example). These are some of the big factors we believe
have driven this move and we do not necessarily see a big change in those coming in the near term.
McCormack:
If you put all that in a blender, where are you finding the opportunities within credit?
Hewitson:
Credit is interesting. We will continue our supply demand analysis and flip it on its head when we are
looking at long duration credit. Long duration credit supply has been lower relative to expectations. That makes
sense for a number of reasons as corporate Treasurers are a little less inclined to lock in these types of yields for
longer terms.
We have seen supply lower than expectations. On the demand side of the market, given about a 6% yield on
long duration high-
quality fixed income, we’ve seen significant interest from a number of different investor types
including pension funds and insurance companies, among others. Putting those two things together, we have
seen the opposite to the Treasury market. This means that long duration risk premium or credit spreads have
been well
-behaved which has manifested in valuations in the market.
The overall corporate bond market is sitting at roughly median spread valuations over the last 10 to 12 years and
the long duration markets were sitting around 10%, with zero being the tightest or the richest. Valuations are
fairly full; however, we think there are significant relative value opportunities within that. That can come in
different ways, maybe amongst the major sectors of the market (being Industrial, Financial, and Utility) or it
could be individual industries within those sectors. We have different points on the credit or yield curve (for
example, 20 year, 30 year, and 40 year maturities can all trade differently) or, of course, idiosyncratic credit risk in
individual credits in the market that we think may be mispriced.
Valuations I would say on the whole look full. That supply demand dynamic could also continue for a long time,
but we believe there are still opportunities within those cohorts for investors in this part of the fixed income
market.
McCormack:
You work with a number of clients that utilize long duration. What do your clients think today
regarding the role LDI plays in their portfolios and how can we help other investors with long duration
mandates?
Hewitson:
The things that we have talked about are not going unnoticed. In our view, it is still a pretty opportune
time for looking at these types of strategies or increasing allocations.
If we focus on the pension market, there are three primary factors to which we could point. One is healthy
funded ratios; as a result of higher interest rates and positive risk asset returns over time, funded ratios are
sitting around a hundred percent on average.
Investment Summit Fourth Quarter 2023
SEGALL BRYANT & HAMILL
• www.sbhic.com
The second being that available yields of around 6% are higher than we have seen in quite some time. And then
lastly, as illustrated in
Exhibit 2
, the average pension plan still only has about a 50% allocation to fixed income
with the other 50% being in equities and other investment types.
In our view, that third factor should begin to, or continue to, increase given the first two factors that we outlined.
Seems to us the prudent thing to do is to start increasing that hedge in light of that position.
Each client's liability or set of circumstances is unique and that is something where SBH feels we can help design
those appropriate strategies for long duration investors to help take advantage of those factors that we see in
the market today.
Ke y Ta ke a ways
•
The recent rise in long
-term yields has been driven by increased Treasury issuance and declining demand
from major investor groups like central banks, commercial banks, and foreign investors.
•
While credit spreads have been reasonably well
-behaved and valuations are full, our team continues finding
relative value opportunities within major sectors.
•
SBH can help design customized LDI strategies to capitalize on high yields based on each client's unique
liabilities and circumstances.
To learn more about SBH Fixed Income Strategies, please reach us at (800) 836-
4265 or contactus@sbhic.com.
This interview was held in November 2023.
All opinions expressed in this material are solely the opinions of Segall Bryant & Hamill. You should not treat
any opinion expressed as a specific inducement to make a particular investment or follow a particular strategy, but only as a
n e
xpression of the
manager’s opinions. The opinions expressed are based upon information the manager considers reliable, but completeness or acc
ura
cy is not
warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can
be
guaranteed. Any and
all information perceived from this material does not constitute financial, legal, tax or other professional advice and is no
t intended as a substitute for
consultation with a qualified professional. The manager’s statements and opinions are subject to change without notice, and Sega
ll Bryant & Hamill is
not under any obligation to update or correct any information provided in this material.
Exhibit 2: Pension Asset Allocation Over Time
Milliman 2023 Corporate Pension Funding Study, April 2023.
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