Opportunities in Long Credit for European Corporate Pension LDI Portfolios

Pimco
By May 29, 2020 11:55

Opportunities in Long Credit for European Corporate Pension LDI Portfolios

For corporate pension funds, increased exposure to long credit could help:

  1. Close the spread duration gap: European corporate pension funds are generally underweight spread duration versus their liabilities. In the current market environment, wider spreads offer an opportunity to invest in long credit at better levels. This should help corporate pension funds achieve a closer match between assets and liabilities by tightening the duration gap.
  2. Lock in liability gains: The recent spread widening has driven down the value of liabilities, as the AA curve corporate pension funds use for discounting is now higher. This has benefited funding positions as LDI portfolios with lower spread duration have not suffered as much.
  3. Unwind credit default swap (CDS) overlays: Some pension funds have hedged their liability spread duration with CDS overlays (iTraxx, CDX or similar). In the recent phases of market volatility, these hedges have not worked well, as CDS levels increased less dramatically than spreads on physical bonds. This has benefitted pension funds’ as CDS hedges (an asset) have declined less than liabilities. However, these gains would be undone if spreads on bonds came back down and the gap versus CDS narrowed. Therefore, this might be a good time to switch from CDS to physical credit solutions to book the gains and improve liability matching.
  4. Interest rates could be lower for longer: PIMCO’s Cyclical Outlook in April stated that we may be entering a New Neutral 2.0– a phase in which real interest rates continue moving lower given low growth, low inflation, as well as other secular forces, including technology. With this in mind, the recent credit sell-off could be a good opportunity for euro investors to lock in investment grade (IG) credit yields at around 2% over bund yields.
Pimco
By May 29, 2020 11:55

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