Buy and Maintain Credit Strategies - Transforming the LDI End-game
Investment objectives evolve over time for plans using liability-driven investing (LDI). In the early stages of a plan’s de-risking journey, the primary objective with respect to funded status is to close the funding gap gradually through some blend of cash contributions and investment returns. Strong investment returns require efficient exposures to diversified investment risk premia and may involve the use of active management and/or high allocations to diversified growth assets. The fixed income allocation may be separated into a credit component and a Treasury component:
- Active management of the credit component is designed to add alpha investment risk premium to the overall return.
- The Treasury component can be customized to deliver an efficient overall interest rate hedge against the plan’s liability profile.
As the plan’s funded status approaches full funding, its primary investment objective shifts more toward stability and less toward growth, calling for corresponding shifts in allocations to growth and fixed income assets. As the need to deliver incremental active alpha return declines, plans may reduce exposure to active management to rationalize future long-term costs. Some may consider designing and implementing a buy and maintain credit portfolio to pursue this objective as they approach their end-game.
Buy and maintain credit portfolios hold well-diversified collections of bonds that are intended to provide payments when a plan needs them. The matching of asset and liability cash flows may be suited to a plan’s end-game. These strategies emphasize fundamental research to underwrite the long-term credit risk of each bond, and de-emphasize shorter-term trading intended to optimize mark-to-market fluctuations or to maintain evolving benchmark requirements. The goal is for the plan to be insulated from factors that impact the market price of its bonds, as long as the bonds do not default; as a result, there generally is no need to buy and sell securities.
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Higher Rates Can Make Equity Hedging More Appealing
We believe put spread collars are a useful risk management tool in this market environment. We also remind plans to remember rho, too, because today’s elevated interest rates can make this classic equity protection strategy even more appealing.
Private Credit – The Calm Before the Storm
The private credit market has generally been resilient this year. The investment-grade and crossover space has seen decent deal flow, pricing discipline, strong premiums and not forgetting a higher yield environment. Tighter credit conditions and bank retrenchment is likely to accelerate the shift towards private market financing, in our view.
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