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Article

Managing Pension Liability Credit Risk: Maintaining a Total Portfolio Perspective

Aaron Meder
The Journal of Portfolio Management Fall 2009, 36 (1) 90-99; DOI: https://doi.org/10.3905/JPM.2009.36.1.090
Aaron Meder
is head of Asset-Liability Investment Solutions, Americas at UBS Global Asset Management in Chicago, IL.
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  • For correspondence: aaron.meder@ubs.com
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Abstract

Widening corporate bond spreads have caused a dislocation between corporate-bond-based pension discount rates and the rates of commonly used interest rate hedging tools. As a result, widening spreads have brought the issue of how to manage liability credit risk to the forefront for plan sponsors. Whereas managing liability interest rate risk via interest rate swaps and/or Treasuries is relatively straightforward, managing liability credit risk is more challenging for three reasons: 1) the credit component of liability returns are not investable, 2) no capital-efficient risk management tool exists to hedge liability credit risk, and 3) the connection between credit spreads and the returns of common risky assets (i.e., equities) is relatively reliable, especially during periods of economic stress when the values of risky assets typically fall as credit spreads widen. In order to construct efficient liability-driven solutions and avoid poor funding ratio outcomes, it is thus essential to view liability credit spread risk from a total portfolio perspective inclusive of risky assets. Meder recommends that, from a long-term policy perspective, plan sponsors should generally avoid credit risk in the liability hedge. From a tactical perspective, however, adding credit risk to the liability hedge when credit spreads are wide and expected to narrow can improve funding ratio outcomes, but the amount of credit risk taken must be appropriately scaled to the total portfolio.

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The Journal of Portfolio Management: 36 (1)
The Journal of Portfolio Management
Vol. 36, Issue 1
Fall 2009
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Managing Pension Liability Credit Risk: Maintaining a Total Portfolio Perspective
Aaron Meder
The Journal of Portfolio Management Oct 2009, 36 (1) 90-99; DOI: 10.3905/JPM.2009.36.1.090

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Managing Pension Liability Credit Risk: Maintaining a Total Portfolio Perspective
Aaron Meder
The Journal of Portfolio Management Oct 2009, 36 (1) 90-99; DOI: 10.3905/JPM.2009.36.1.090
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  • Article
    • Abstract
    • UNDERSTANDING PENSION LIABILITY DISCOUNT RATE RISK
    • IMPROVING THE EFFECTIVENESS OF THE LIABILITY HEDGE
    • MAINTAINING PERSPECTIVE
    • FOCUS ON THE FUNDING RATIO
    • TACTICAL CONSIDERATIONS
    • CONCLUSIONS
    • ENDNOTES
    • REFERENCES
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