Three Questions on Credit: Considerations for Corporate Pension Plans

HOW WERE PLANS POSITIONED PRIOR TO THIS DOWNTURN AND HOW HAVE THEY BEEN AFFECTED BY RECENT EVENTS?

Nearly all pension plans will have lost funded status in this downturn. The question is: how much? We estimate the average plan's allocation was approximately 55% in return-seeking assets (RSA) and 45% in liability-hedging assets (LHA) going into this period. Plans with this type of asset mix may have experienced a drop of approximately 12%-14% in funded status year to date through March 31. More aggressive plans or those less hedged against interest rates may be down by more than 16%. Even plans with significant LHA allocations may be down by approximately 3%-4%. While cash contribution requirements are unlikely to be an issue in the immediate near term due to smoothing rules, balance sheets have taken a hit and Pension Benefit Guarantee Corporation premiums are likely to be higher. Overall, there is a higher mountain to climb for nearly all plans.

HOW ARE PLANS DEALING WITH GLIDE PATHS AND REBALANCING?

Re-risking discussions are common and varied. Many plans have tapped Treasury allocation overweights as a source of capital for a wide range of purposes, including rebalancing into equity or credit, benefit payments, and margin or capital calls. The resulting stress on Treasury market liquidity has recently dissipated but remains a concern as the Fed scales back in April. We do see value in rebalancing back into equity and credit in a thoughtful manner as long as it is couched in the context of overall plan objectives and funding ratio risk budgets. However, we would caution against wholesale unwinding of long-duration hedges given the transaction costs and potential of having to buy back the same securities if/when we see funded status improve. In any event, the recent turmoil has highlighted the robustness of glide path governance and decision-making authority, both good and bad.

WHAT ARE THE POTENTIAL OPPORTUNITIES FOR PENSION PLANS GOING FORWARD?

Most equities and credit assets are cheaper now than they were earlier this year. The extent to which plans move in should depend on plan-specific factors, but we expect a continued surge in rebalancing activity in the coming weeks. For many plans, it still takes time to efficiently shift large amounts of capital into cheaper assets. We see value in having a diversified credit strategy as part of an LHA allocation that can efficiently access asset classes outside of traditional long corporate bonds (e.g., securitized, high yield, bank loans, emerging market debt). By packaging this type of strategy with a simple overlay to extend duration, plan sponsors may get a diversified hedging strategy that is uncorrelated to other managers while seeking to provide additional levers to outperform the liability. Recent spread widening has made this type of strategy potentially more interesting today.

Disclosure

Past performance is no guarantee of future results.

Diversification does not ensure a profit or guarantee against a loss.

This paper is provided for informational purposes only and should not be construed as investment advice. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Other industry analysts and investment personnel may have different views and opinions. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted, and actual results will be different. Data and analysis does not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.

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