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Pension Curve Insider: LDI Solutions May Monthly Recap

Aaron Stonacek, ASA, CFA, Solutions Analyst
Justin Harvey, Solutions Strategist for Multi-Asset Solutions

Monthly Recap

Marked-to-market discount rates nudged up in April as the Treasury curve had a rare bout of steepening. The short end of the curve remained still while the long end jumped about 10 basis points between the 7 and 30-year tenors. Discount rates generated using the AA-rated spot and top-yielding curves reacted by inching up 4 and 2 basis points, respectively. Spreads continue to contract, with A and AAA-rated bonds tightening 3 to 4 basis points. Discount rates based on the IRS curve, with its averaging methodology, fell during the month.

Discount rates sit 24 basis points lower than a year ago, using the broad AA discount rate curve. Top yielding AA-rated bonds are 17 basis points lower than April 2018 and provide 27 basis points of additional yield relative to the broader market.

Turnover maintained the meager pace set last month, with only about 1.5% of the AA-rated index changing eligibility during the month. Bonds entering the AA-rated index made up the month’s only constituency changes. Entering bonds were highlighted by a handful of large issuers. Wal-Mart, Blackrock, and three Canadian provinces each contributed $1B+ offerings during the month, which primarily impacted the middle and long end of the discount curve.

Liability Impact

Yield Curve

Liability Value 4/30/19

Discount Rate
4/30/19

Liability Value 3/31/19

Discount Rate 3/31/19

Liability Value 12/31/18

Discount Rate 12/31/18

Accounting
Yield Curve

$10,147

3.90%

$10,207

3.86%

$9,695

4.24%

Top Yielding
Accounting Curve

$9,784

4.17% $9,806 4.15% $9,446 4.43%

IRS Yield Curve

$9,928

4.03% $9,790 4.14% $9,400 4.44%

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. IRS, and T. Rowe Price. Sample plan cash flows have a liability of $10,000 at 4.0% discount rate.

Accounting Curve

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.

Issuer

Event

Curve Impact


Wal-Mart

New Issue

(3 bonds)

Wal-Mart issued 3 new bonds during the month that entered the AA-rated index. The total market value of the issuance eclipsed $4B, with maturities spread over the 3, 5, and 10-year tenors. Most of the impact on discount rates was felt at the 5 and 10-year points, shifting the curve 2-3 basis points.

Blackrock

New Issue

(1 bond)

Blackrock also issued one new bond during April, amounting to just over $1B in market value and maturing at the 10-year point in 2029. The issue hit discount rates at the long end, in conjunction with Wal-Mart’s 10-year bond, reducing the curve’s yield a couple of basis points.

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.

 

New Issues

Other Bonds Entering

Downgrades

Other Bonds Exiting

April 2019

Count

10

0

0

0

Market Value ($M)

$10,879

$0

$0

$0

Market Value (%)

1.66%

0.00%

0.00%

0.00%

 
2019 YTD

Count

35

5

5

18

Market Value ($M)

$32,255

$5,553

$6,957

$16,126

Market Value (%)

4.97%

0.86%

1.07%

2.50%

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.

Top Yielding Accounting Curve

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.

IRS Curve

Sources: IRS and T. Rowe Price

Dates

AAA Corporate OAS

AA Corporate OAS

A Corporate
OAS

March Monthly Average

56

49

86

April 1, 2019

58

50

86

April 15, 2019

52

48

79

April 29, 2019

53

47

81

April Monthly Average

54

48

81

Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2019, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.

One-Year Rolling Returns and Tracking Error

 

April 2019 Return

YTD Total
Return

Annual Tracking Error Relative to Liability

Average Monthly
Return Difference from Liability

Hypothetical Sample Plan Liability

-0.30%

5.93%

NA

NA

BBgBarc Aggregate

0.03%

2.97%

6.44%

1.40%

BBgBarc Long Credit

0.61%

8.52%

4.50%

0.92%

BBgBarc Long Gov/Credit

-0.40%

6.03%

3.10%

0.64%

Hypothetical T. Rowe Price Custom Benchmark

-0.08%

6.15%

2.02%

0.32%

Sources: Bloomberg Index Services Ltd., T. Rowe Price; Analysis by T. Rowe Price. Performance shown in graph and tables above shown from February 1, 2005 through April 30, 2019.
Past performance cannot guarantee future results. Custom Benchmark returns do not reflect the deduction of management fees. Please refer to the disclosure at the end of the article for important additional information.
Copyright 2019, Bloomberg Index Services Ltd. Used with permission.

Glossary

IRS Yield Curve: Plan sponsors of qualified defined benefit pension plans use this yield curve to determine funding requirements per IRS regulations. These funding requirements are disclosed on form 5500 annually. Yields on AAA, AA, and A corporate securities determine the yield curve for discounting purposes. The yield curve is not a marked-to-market curve representing any single date, but rather an average yield over the course of the entire month. For more information on the IRS methodology, please see treasury.gov/resource-center and irs.gov/Retirement-Plans.

Accounting Yield Curve: US GAAP requires pension plan sponsors to disclose pension obligations using “fixed-income debt securities that receive one of the two highest ratings given by a recognized ratings agency”. As a proxy for bonds useable for accounting purposes, we use the constituents of BBgBarc AA credit universe to develop the accounting yield curve shown. Please see fasb.org for more information.

Top Yielding Curve: Since the US GAAP rules allow the use of a fairly broad range of securities for accounting purposes, some plan sponsors use an optimized yield curve approach to value their pension liabilities on the disclosure dates. Bonds trading at higher yields than other bonds of similar maturity tend to be used for this purpose. To quantify the effectiveness of this approach, T. Rowe Price developed a yield curve using the highest yielding bonds designed to meet SEC requirements at each node.

Annual Tracking Error Relative to Liability: Calculated as the standard deviation of return differences between a fixed income index and a set of cash flows discounted using the accounting yield curve. The liability return has two components: an interest cost component analogous to roll return on a bond, and yield change component analogous to price return on a bond. The table shows annualized ex-post tracking error.

Average Monthly Return Difference: Similar to the tracking error metric, this metric demonstrates how closely a fixed income benchmark tracks a set of liability returns. We calculate this measure by simply averaging the difference in returns over the period shown.

Sample Plan Liability: Pension plan sponsors must account for the cost of their retirement plan on their financial statements. The amount of this liability can fluctuate over time based on several factors, including benefits earned, benefits paid out, mortality experience, and most significantly, interest rates. The Sample Plan is intended to be a representative defined benefit pension plan and does not reflect the cash flows from any specific plan.

T. Rowe Price Custom Benchmark: An index of fixed income securities created using T. Rowe Price proprietary methodology that attempts to replicate interest rate exposures embedded in a pension plan’s liability structure.

To learn more, please visit troweprice.com

Important Information
This material is directed at institutional investors or advisors/consultants to institutional investors only and is not intended for distribution to retail investors. It has been prepared by T. Rowe Price Associates, Inc. for informational purposes and is not intended to be investment advice or a recommendation to take any particular investment action. This material should not be redistributed, in whole or in part, without prior consent from T. Rowe Price. The views and information contained herein are as of 30 April 2019 and are subject to change without notice.

The illustrations presented are hypothetical and used to demonstrate capabilities. Certain assumptions have been made for modeling purposes and with the benefit of hindsight and are unlikely to be realized. The specific issuers and bond issues mentioned in this document had significant impact on liability curves calculated using BBgBarc index universes. The modeling used for plan and benchmark development has certain inherent limitations. Benchmark construction may not reflect all material economic and market factors that could have impacted implementation or weighting decisions if the modeled plan actually existed during the time period presented. Actual T. Rowe Price Custom Benchmark characteristics, including (among other things) yield, annualized return, liability-relative tracking error and average monthly returns difference relative to plan liability may differ substantially from the hypothetical scenario presented.

T.ROWE PRICE, INVEST WITH CONFIDENCE and the bighorn sheep design are collectively and/or apart, trademarks of T. Rowe Price Group, Inc. © 2019 T. Rowe Price. All rights reserved.

201905-851110

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