When the Market Flips its Lid, What Does it Mean for LDI?
To date, 2020 has been characterized by tremendous market volatility globally driven by the COVID-19 pandemic, and not just in equity markets. In the U.S., investment grade credit spreads tested five-year lows during the first two months of the year, then quadrupled before falling back to “normal” levels after the Federal Reserve announced it would buy investment grade bonds to support the corporate credit market. Key interest rate benchmarks in various countries tumbled as their central banks intervened to try to stimulate economies impacted by COVID-19; the bellwether 10-year U.S. Treasury yield has dropped well below 1% and remains there, the yield on Germany’s 10-year Bund plunged to –0.86% in March before “recovering” to somewhere above –0.50%, and some UK government bonds are offering negative yields for the first time (and the U.K. is of course facing Brexit at year-end).
Ultra-low interest rates in many developed countries have caused investors, asset managers and risk professionals to wonder what this means for the future of inflation in these economies. Ever since the 2008 Financial Crisis, central banks have been trying to bring inflation up to a 2% target and now declines in business and consumer activities and soaring unemployment have stifled demand in many sectors of their economies.
An area of investment management that is particularly exposed to changes in interest rates (nominal and real) is the world of Liability-driven Investing (LDI). Volatility and declining interest rates present problems for defined benefit pension plan plans and other entities with fixed payment obligations, as lower interest rates increases the present value of those liabilities while declining government bond yields make it more challenging to earn a sufficient investment return without taking on too much risk.
In response to the inquiries we have received on the subject of LDI, we produced an eBook on the topic that you can download here. It provides an overview of the concept, and then dives into the key questions regarding risk management for liability-driven investing and provides technology tips to help those who might be considering purchasing, changing or upgrading their LDI solutions for their needs. We hope you find this useful and, as always, we welcome your feedback.