Pension investors are increasingly considering interest-rate derivatives to manage duration in fixed-income portfolios, a development that could weaken the bid for long Treasuries. The trend is picking up now as yields on Treasuries grind thinner and the benchmark 10-year heads toward the lowly 4% mark. The drive to better match assets and liabilities come on the heels of Bush administration proposals to reform the system. "We've seen a lot more discussion about [using interest-rate derivatives]," said Robert Blackwell, pension fund consultant at Russell Associates.
Many fund assets are considerably shorter duration than their liabilities, since most fixed income is benchmarked against the Lehman Brothers Aggregate Bond Index, according to Bruce Jurin, head of J.P. Morgan Securities' pension advisory group. While the Lehman Ag has a duration of around 4.42 years, pension plans' average liabilities is around 13 years but can go up to 20 depending on the plan's type. "The typical long bond portfolio does not have enough duration to match assets with liabilities," Blackwell said, noting most such portfolios only have a duration of 12 years.
But, pension managers are expected to eventually manage duration more through interest-rate derivatives than cash bonds because Treasuries provide less return and are extremely rich, according to Kurt Winkelmann, head of global investment strategies for Goldman Sachs Asset Management. The derivatives could involve interest-rate swaps, options and futures and the simplest example would involve entering an interest-rate swap in which the pension fund pays floating and receives a fixed rate.
Some large firms have already been producing strategies specifically targeted at better matching assets and liabilities for pension funds and use interest-rate derivatives, Blackwell said, noting Pacific Investment Management Co., Western Asset Management Co. and Wellington Management are among the firms that have such strategies.Lisa Finkel, Wellington spokeswoman, declined comment on the asset manager's products.Gavin James, WAMCO spokesman, and James Clarke, PIMCO spokesman, did not return calls by press time.
