Stop waiting on interest rates to manage DB risk and volatility!
A recent paper published by Principal Financial Group® says it can be possible. (PDF: 694 KB)
It’s a common belief that interest rates have nowhere to go but up. And because bond investments typically go down in value when interest rates go up, plan sponsors may be avoiding investments in bonds in favor of other options. As the duration – that is, the length of the maturity of the bond – extends longer, the larger the decline in the bond investment will likely be if interest rates increase. So plan sponsors that invest in bonds have generally been sticking to shorter duration bond investments.
If a plan sponsor feels interest rates will go up, should they avoid bonds – and in particular longer duration investments? According to this article, that is not necessarily the case.
Three scenarios put to the test
Three different hypothetical interest rate scenarios were evaluated. The results may surprise you. Given these scenarios, it can be beneficial to consider a “middle of the road” approach (where a bond portfolio matches the duration of the bonds with the plan liability).
Of course, a crystal ball would help. No one can accurately predict when interest rates will change and by how much. But as this research indicates, it may be possible to maximize the investment return of a plan’s bond portfolio while at the same time controlling or limiting the volatility of a plan’s funded status. This seems counter-intuitive to what most plan sponsors are doing today – which is investing in short term core bond investments due to their concerns over interest rate increases.
To learn more, read the full paper on fixed income strategies that can work in any interest rate environment. (PDF: 694 KB)
In addition to blogging here, I also tweet regularly about DB topics of interest. Click to follow me on Twitter- @scottruba.
The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Investment options are subject to investment risk. Shares or unit values will fluctuate and investments, when redeemed, may be worth more or less than their original cost.
No investment strategy, such as asset allocation or diversification, can guarantee a profit or protect against loss in periods of declining values.
Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise. Neither the principal of the bond investment options nor their yields are guaranteed by the U.S. government.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.