Massive Rotation?

A Bank of America research note published recently suggests that the significant improvement in corporate pension plan funding (Milliman calculates the collective funded status at >98%) will likely lead to a “massive rotation” from equities into corporate bonds. We absolutely agree that it should. Many private sector pension systems have frozen and terminated their pensions during the last 4 decades, but many 1,000s still exist. For those that haven’t yet terminated or frozen their plan, engaging in a de-risking strategy at these funding levels makes absolute sense. Why wait? Market timing, predicting equity markets and interest rates, shouldn’t be driving this decision. For instance, the US Treasury 10-year note has rallied despite inflationary expectations and the yield sits at 1.47% this morning down from 1.75% on March 31, 2021. Most market participants were expecting rates to continue to climb.

“I think this becomes a pretty big story, and it becomes a support for credit spreads in the back end of the curve
especially,” Hans Mikkelsen, BofA’s head of high-grade credit strategy, said in an interview. We agree that it likely supports credit spreads, which have tightened, but we disagree that it particularly supports the back-end of the curve. Engaging in asset liability management (ALM) is NOT about buying long corporate bonds. Effectively managing assets versus plan liabilities calls for the cash flow matching of assets along a liability yield curve of projected annual benefit payments, with the next month’s benefit payment being the most important. Sitting with a bunch of long corporate bonds and thinking that you have somehow “immunized” the  assets to match liabilities is just wrong, while opening the plan to significant interest rate risk.

There are only two ways to secure benefits – insurance buyout annuities (IBA) and cash flow matching (CDI). Doing a pension risk transfer through an IBA can be very expensive, especially relative to managing the plan’s liabilities through a cash flow matching strategy. Our experience and analysis suggest that a CDI approach can save the plan about 30% on the future costs of the benefit relative to engaging in an IBA. Furthermore, if a plan is focused on eventually doing a pension risk transfer a cash flow matching portfolio is the perfect vehicle to meet this objective as the insurance company will likely be happy to do a portfolio transfer-in-kind. Go to to see multiple research pieces on this subject.

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