As defined-benefit plan sponsors consider reconstructing their portfolios in response to COVID-19, they shouldn’t ignore the impact of Treasury rates.
The COVID-19 crisis has forced pension managers to come to terms with vulnerabilities in their portfolios. The combination of falling asset prices and interest rates has had a damaging impact to a key measure of corporate defined-benefit pension health: funded status. Funded status is determined by both portfolio assets and pension liabilities, with liabilities valued using corporate bond yields. This interplay at times makes it difficult to assess a particular market environment’s effect on funded status.
At the beginning of the current crisis, US Treasury yields fell dramatically, culminating with the Fed’s unprecedented two-step rate cut to 0% in the first half of March. But credit may have hidden some pension liability volatility throughout that month. The below chart compares the portions of liability returns attributed to changes in the US Treasury rate curve, changes in credit spread, and other residual factors such as cash flows.
Liability return attribution
Source: Parametric, FTSE, ICE, 6/30/2020. For illustrative purposes only. The data provided herein is derived from the FTSE Pension Liability Index. It is not possible to invest directly in an index. Indexes are unmanaged. Not a recommendation to buy or sell any security. Past performance is not indicative of future returns.