Mercer said the new strategy is intended to be used in conjunction with its Liability Driven Investment (LDI) approach, which seeks to improve the correlation between pension plan assets and liabilities. Mercer explained that the new strategy’s investment performance and the present value of plan liabilities are both affected by the level and movement of corporate bond yields which are the primary drivers of the expected correlation.
Mercer noted that compared to Treasuries, the new strategy has increased corporate credit exposure with a corresponding increase in default risk, and that there is relatively less liquidity in corporate bonds which has also impacted their relative valuation. However, Mercer said for long-term investors, these risks must be weighed against the potential opportunity for favorable returns and lower funded status volatility.
“The valuation of plan liabilities is based on discount rates tied to high-quality corporate bond yields. Assuming yield levels ‘normalize’ and corporate bond yields decline relative to Treasury bonds and long-dated interest rate swap yields, both of which are commonly used in LDI strategies, the Mercer long duration investment grade credit strategy is designed to benefit pension plans on a relative basis,” said Christopher Ray, head of US investments at Mercer, in a press release. “We believe the relative valuations of Treasuries, long-dated interest rate swaps, and investment grade corporate bonds in today’s market are receiving increased attention. We anticipate that LDI investors, as well as those pursuing traditional relative value investment strategies, will seek to exploit the opportunity that we see in corporate bonds.”
More information is at www.mercer.com .