Making Surpluses Stay
マイルズ・ブラッドショーとイェルーン・ヴァン・べズーイェンの略歴はこちらをクリックしてください。Since August last year, we have become accustomed to “bad news,” be it the runs on Northern Rock or Bear Stearns, higher mortgage rates or weaker economic growth. But every cloud has a silver lining, in this case for UK pension funds. Wider risk premiums have created opportunities for unlevered investors to earn higher returns. UK pension funds fall into this category as they typically do not borrow in order to invest. So how can pension fund investment strategies exploit the recent market dislocations?
In this installment of the European Perspectives we highlight three ways pension funds can potentially benefit from these market conditions and make the surplus stay:
For pension funds that have adopted or are considering adopting a liability-driven investment (LDI) strategy, all the above points indicate that a “hands-on” active management approach likely offers more value than a passive “implement-and-forget” approach to LDI.
A better matchWider credit spreads are not only good news for pension funds because of their impact on the FRS 17 funding levels. Buying credit at current spreads also provides pension funds with an interesting opportunity to earn equity-like returns with fixed-income investment risk levels.
Since the 160 bps panic levels of March 2008, spreads as measured by the iTraxx Main index, have fallen back to 75 bps in mid-May. Yet this is still almost four times the pre-crisis levels and implies a default rate of 5.7% against the average 5-year cumulative default rate of less than 1% as measured by Moody’s. This average default rate equates to about a 20 bps annual loss (compared to an annual spread earned of 75 bps). On the downside, the worst cumulative 5-year default loss (since 1970) has been 3.5%, or about 70 bps per annum, which is still below the current spread earned.
The higher implied default rate reflects the expectation that weaker economic growth will be a drag on credit fundamentals going forward. This risk is more than adequately priced into the investment grade credit market with ratings of BBB and higher. (NB: High yield bonds with ratings of BB and lower are a different story). So, as an asset class we think investment grade credit is attractive.
PIMCO has estimated that at current levels, the spread on BBB corporates is indeed close to the typical equity risk premium assumption of 2-4% as shown in Chart 1. This means that pension funds can now switch from equities into (corporate) bonds without having to sacrifice as much return or inject as much capital as in the last decade. At the same time they can move higher up the corporate capital structure. In short the “crisis” has improved the terms for pension funds to better match their assets and liabilities by switching from equities into bonds.
The benefits of using the iTraxx CDS indices is that pension funds do not need to invest £100 of cash to get £100 of exposure. As with other derivatives contracts, investors only need to have physical cash or other collateral (such as gilts) to cover the initial and subsequent variation margins. Pension funds can therefore sell protection on the iTraxx Main index as an overlay strategy over their existing bond portfolio in an effort to boost returns and reduce the mismatch risk between the discount factor on their assets and the FRS 17 discount factor on their liabilities.
While the investment strategy seems clear, the implementation is less straight-forward. For a start there is the issue of liquidity. Using ML indices as a guide the 15-year+ non-gilt index is £116 billion in size against £142 billion in the 15-year gilt index. However, the gilt index underestimates the true size of the long-dated interest rate market in the UK because it excludes the swaps market. Liquidity is in fact much poorer in long-dated non-gilts with bid-offers typically in the range of 0.5%-1% as opposed to 0.1% - 0.15% in long gilts. A second problem is duration. The gilt index has a duration of 14.9 years compared to 11.9 years in the non-gilt index, but this can easily be remedied by extending asset duration with an interest rate overlay. A lesser concern is the ratings, since most non-gilt issuers are of high quality: the average rating on the non-gilt index is AA2.
Adding up the pros and cons, pension funds may be better off with long-dated investment grade corporate bonds. Despite the limitations of the lower liquidity and smaller size of the long-dated corporate market, the excess yield currently available more than compensates for this. Given the excess yield, pension funds with gilt assets may want to think carefully about whether they would not be better rewarded through long-dated investment grade corporate bonds instead of gilts.
The trick with inflationThe high yield offered by long-dated corporate bonds also has implications for pension funds’ inflation strategy. This is especially the case with respect to liabilities with LPI indexation which account for a large part of many pension funds’ liabilities. The current inflation picture appears relatively bleak. Let’s start with the Bank of England’s (BoE) inflation target of 2% measured by the consumer price index (CPI). A CPI inflation of 2% is consistent with the UK’s other inflation measure, the retail prices index (RPI), between 2.5%-2.7% (depending on house price inflation assumptions).
Long-dated index-linked real yields currently range between 0.5%-1%, implying break-even rates of inflation between 3.65% (for 15-year bonds) and 3.8% (for 30-year bonds). Consequently, this market pricing implies that the BoE will fail to maintain inflation near its 2% target on average for the next 30 years.
We know that 30-year break-even inflation rates are so high (and real yields so low) because of a distortion created by structural demand from pension funds seeking to hedge their inflation-linked liabilities. For if the market truly did think the BoE would miss its inflation target then the yield curve section between 10-30 years should be steep, rather than inverted, to compensate investors for the higher expected inflation over the period.
However, LPI requires schemes to index liabilities to RPI inflation subject to a ceiling of (usually) 5%5. There is a derivatives market in RPI and LPI inflation swaps (whereby the investor agrees to pay/receive inflation and receive/pay a fixed rate) which suggests the respective inflation expectations. 30-year RPI swap break-even rates are currently at about 3.8% while 5%-cap LPI swap break-even rates stand at 3.7% – this is again inconsistent with the BoE’s inflation mandate. Given 30-year nominal interest rate swaps of 4.7%, this equates to a real LPI yield of 1%. In other words, pension funds would receive a 1% yield plus RPI inflation, subject to a cap of 5% in any one particular year.
Putting all the pieces together, the widening in credit spreads means that pension funds can now buy long-dated non-gilt assets yielding 6%-6.5% as of mid-May. Thus, the yield will exceed the indexation by at least 1%-1.5% as this is capped at 5%. If the BoE succeeds in hitting its inflation target (and delivers RPI of 2.5%), pension funds will have captured an additional 2.5% per annum by buying long-dated non-gilts (yielding 6%-6.5%) rather than receiving a 1% net yield (based on fixed nominal rates of 4.7% less the fixed coupon of 3.7% to receive 30-year LPI inflation). If the BoE fails to meet its inflation mandate, then the pension fund is no worse off as the maximum their liabilities can increase in any one year which is 5%. Given the implied expectation that the inflation target will be met, this sounds like a good value proposition with limited downside risk
Choosing the right tool when increasing durationIt has become increasingly popular for pension funds to increase asset duration by receiving swaps rather than buying gilts. This largely reflects the greater customization of swaps and the deeper liquidity of the market. For example, pension funds can decide both the start and their final maturity of the swap, be it 30 or 47½ years.
But when pension funds receive fixed rates they also commit to paying floating rates (6-month Libor) to their counter-party. And one feature of this liquidity crisis has been the sharp rise in Libor rates. 6-month Libor stood around 5.8% in mid-May, some 80 bps over the risk-free rate (defined here as the 6-month Sterling Overnight Index Average (SONIA)), up from about 15 bps before the crisis. This would be less relevant if 30-year swap spreads had also widened.
However, partly because of this structural demand from pension funds to hedge inflation-linked liabilities, the spread between 30-year swap and gilt rates has narrowed to less than 20 bps from about 35 bps prior to the crisis. So, by receiving fixed rates, pension funds are now receiving 20 bps over the risk-free fixed (gilt) rate and paying 80 bps over the risk-free floating rate. This 60 bps cash flow deficit is unlikely to remain so wide for the duration of the swap (indeed, the market discounts that this spread will fall to 20 bps by early 2010). Given the increased focus on liquidity ratios, though, the deficit is unlikely to fall back to pre-crisis levels. In short, the cost of receiving on long-dated swaps has gone up since the crisis began.
Pension funds now need to earn an additional return on their cash assets in order to offset the higher Libor rates. So what should pension funds do about this? Those looking at implementing swap overlays may consider re-assessing the merits of implementing the same strategy using cash bonds – whether they are gilts or corporates. If cash bonds are not an option, schemes can alternatively look at using forward starting swaps. This strategy postpones the need to exchange cash flows to when conditions might be more favorable.
Becoming activeThe strategies outlined above indicate the many ways in which pension fund investors in the UK market can benefit from recent market events, especially with respect to LDI strategies. While the opportunities are out there, schemes need to make an active decision to participate. In this environment, a passive “implement-and-forget” approach to LDI is likely to be sub-optimal. Schemes likely need to become active or enlist the help of a hands-on asset manager to exploit the opportunities on offer and make their surplus stay.
Myles Bradshaw Vice PresidentJeroen van BezooijenSenior Vice President
1 Market prices, yields and spreads quoted were taken on 13 May, 2008.2 The iTraxx Main index consists of the most liquid 125 investment grade names and has an average rating of A. 3 Using 10-year gilt yields.4 LPI typically caps inflation at 5% (and floors at 0%).5 For example: If inflation is 10% in Year 1 then the liabilities will only increase by 5%.
ピムコジャパンリミテッド 105-0001 東京都港区虎ノ門4-1-28虎ノ門タワーズオフィス18階 金融商品取引業者 関東財務局長（金商） 第382号加入協会/ （社）日本証券投資顧問業協会､（社）投資信託協会ピムコジャパンリミテッドが提供する投資信託商品やサービスは、日本の居住者であり、かつ法律による制約のない方に対して提供するものであり、かかる商品やサービスが許可されていない国・地域の方に提供するものではありません。過去の実績は将来の運用成果を保証するものではありません。本資料には、本資料作成時点での著者の見解が含まれていますが、これは必ずしもPIMCOグループの見解ではありません。著者の見解は、予告なしに変更される場合があります。本資料は情報提供を目的として配布されるものであり、投資助言や特定の証券、戦略、もしくは投資商品の推奨を目的としたものではありません。本資料に記載されている情報は、信頼に足ると判断した情報源から得たものですが、その信頼性について保証するものではありません。本稿に含まれるデータは、本稿の作成された時点でのデータに基づいており、変動します。債券市場への投資は市場、金利、発行者、信用、インフレなどに関するリスクを伴うことがあります。高利回りで低格付けの債券はより高格付けの債券よりも高いリスクを伴います。デリバティブ商品を利用することにより、コストが発生する可能性があり、さらに流動性リスク、金利リスク、市場リスク、信用リスク、経営リスク、そして最も有利な時点でポジションを清算できないリスクなどが発生する可能性もあります。デリバティブ商品やモーゲージ関連商品への投資により、投資元本以上の損失を蒙る可能性もあります。デリバティブ商品への投資により、投資元本以上の損失を蒙る可能性もあります。スワップは非公開で締結される二者間の契約であり、スワップ取引には中心となる取引所や市場は存在しないため、取引所取引の商品に比べて、流動性が低くなります。消費者物価指数(“CPI”) は米労働統計局の規定に従い、米国消費者物価の上昇率を示す合成インデックスです。CPIやその他の指数が随時、インフレの正確な水準を示すという保証はありません。LIBOR（ロンドン銀行間預金金利）は銀行間の短期のユーロドル・ローンに対して課される金利です。RPI(Retail Prices Index)とは、英国小売り物価指数の加重指数であり、平均的な英国の商品及びサービスの価格変動を表した指数です。RPIには、食品、飲料、タバコ、住宅、家庭日用品とサービス、人的財貨とサービス、運輸費、運転費、衣料、レジャー用品及びサービスの価格を含みます。この指数は月次でまとめられ、一度公表すると改訂はされません。運用を行う資産の評価額は、組入有価証券等の価格、金融市場の相場や金利等の変動、及び組入有価証券の発行体の財務状況による信用力等の影響を受けて変動します。また、外貨建資産に投資する場合は為替変動による影響も受けます。運用によって生じた損益は、全て投資家の皆様に帰属します。したがって投資元本や一定の運用成果が保証されているものではなく、損失をこうむることがあります。弊社が行う金融商品取引業に係る手数料または報酬は、締結される契約の種類や契約資産額により異なるため、当資料には具体的な金額・計算方法は記載しておりませんのでご了承ください。本資料の一部、もしくは全部を書面による許可なくして転載、引用することを禁じます。本資料の著作権はＰＩＭＣＯに帰属します。 2008年
（注）ＰＩＭＣＯはパシフィック・インベストメント・マネジメント・カンパニー・エルエルシーを意味し、その関係会社を含むグループ総称として用いられることがあります。