By: Russ Kamp, Managing Director, Ryan ALM, Inc.
The inflationary environment and the impact of Federal Reserve tightening are combining to create a challenging environment for traditional fixed income core mandates – the significant majority of fixed income exposure among public and multiemployer pension systems. The year-to-date performance for the Bloomberg Barclays Aggregate index reveals a -6.3% return through yesterday’s market close (3/29). As we’ve pointed out on several occasions, fixed income market participants have enjoyed quite the run during the last 39-year bull market. But the party may have just received the final call. So, just how bad is the nearly completed first-quarter return? It is ugly.
Since 1980, the Aggregate index has declined only 4 times on an annual basis. Four times in 42 years! The most significant annual decline was only -2.92% (1994), or <50% of the decline observed during the first three months of 2022. The worst quarter during this extraordinary period was -4.1% (quarter ending 9/81). This shouldn’t come as a major surprise to anyone who regularly reads this blog, as we’ve been saying for quite some time that the current inflationary environment would lead to Fed tightening AND that this action would also be quite bad for traditional bond management. Given that the US Federal Reserve has indicated future interest rate increases at each of the remaining FOMC meetings for 2022, the interest rate rise witnessed to date is only a small deposit of what’s to come.
We strongly encourage plan sponsors and their advisors to refocus their plan’s fixed-income away from a return-seeking mandate to one that uses bond cash flows to match and fund the plan’s liability cash flows (benefits and expenses). This action will ensure that the portion of assets used to defease the plan’s liabilities will move in lockstep. We don’t know the magnitude or duration of a potential interest rate increase, but we certainly have history to guide us. Prior to the astonishing 39-year bull market, we suffered through a 30-year bear market that was accompanied by high inflation, oil shocks, political instability, and significantly rising US interest rates. Sound familiar?