Rethinking The Use of Active Fixed Income In A DB Plan

P&I just posted their performance study by Morningstar. As usual, it shows little or no value in ACTIVE bond management over most time frames. Moreover, given today’s low yields the question is: What is the value in bonds if one is striving to achieve the ROA?

Answer: CASH FLOW
Bonds are the only asset class with a known future cash flow and future value. That is why bonds have been picked as the choice for defeasement, dedication, immunization, and LDI strategies.

Instead of maintaining your current active fixed income program convert it to a Liability Beta Portfolio (LBP).  The LBP model is a cash flow matched model that provides the matching of liabilities at low cost and importantly, low risk. Versus ASC 715 discount rates (AA corporate securities)  funding costs are reduced by 8% to 12%. At a fee of only 10 bps, the LBP would be a proper replacement of active bond management, which has a 25 bps to 30 bps average fee. Given a 20% allocation to bonds, inclusive of contributions, the LBP model could possibly fund the next 7-10 years of liabilities with no change to the plan’s current asset allocation.

The true question is: Why have active bond management when you can de-risk the plan gradually with a LBP model that will reduce the cost of funding liabilities, while also reducing significantly fixed income fees?

Please don’t hesitate to reach out to Ryan ALM and KCS to discuss this concept in more detail.

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