December 2021 / INVESTMENT INSIGHTS
Pension Curve Insider: LDI Solutions November Monthly Recap
Monthly Recap
Intermediate-term Treasury yields rose during the month of November, while corporate spreads remained stable through the month. The discount rates for a sample plan liability declined by 4 basis points for both the AA-rated spot curve and the top-yielding curve.
Plan liability values increased slightly on a marked-to-market basis, extending their increase from the prior month. Spreads widened marginally, and the top-yielding curve provided 36 basis points of additional yield at month end versus the broader AA-rated universe.
Issuance for the month of November totaled $8.4B, a similar volume to the previous month. New issues had a minor upward impact on the short to intermediate segments of the curve. No turnover occurred due to credit rating changes, and only one bond exited the universe.
Liability Impact
| Yield Curve | Liability Value 11/30/21 |
Discount Rate 11/30/21 |
Liability Value 10/31/21 |
Discount Rate 10/31/21 |
Liability Value 12/31/20 |
Discount Rate 12/31/20 |
|---|---|---|---|---|---|---|
| Accounting Yield Curve |
$11,986 | 2.74% | $11,913 | 2.78% | $12,288 | 2.57% |
| Top Yielding Accounting Curve |
$11,357 | 3.10% | $11,293 | 3.14% | $11,456 | 3.04% |
| IRS Yield Curve | $11,794 | 2.83% | $11,789 | 2.84% | $12,182 | 2.62% |
Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2021, 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 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
| Issuer | Event | Curve Impact |
|---|---|---|
| Westpac Banking Corp | New Issue (2 Bonds) |
Westpac Banking Corp issued two new bonds dated to mature in 2024 and 2028, each with notional values of $1.25B. The Australian bank’s combined offering represented the largest across all issuers during the month. The bonds traded wide of similar-dated issues at month end. |
| Shell International Finance | New Issues (2 Bonds) |
Shell International Finance, the Netherlands-domiciled funding subsidiary of Royal Dutch Shell plc, came to market with two bonds totaling $1.5B. The new issues bring Shell’s total market value within the index to $37.8B. The energy conglomerate represents the third-largest issuer in the AA-rated index, with a share of 5.3%. |
| Hong Kong | New Issue (1 Bonds) |
The Government of Hong Kong (HKSAR) offered a $1.0B ESG-focused bond during the month of November. Funds from the ten-year maturity bonds were raised with the intention of funding renewables projects. The issues traded tighter than bonds of similar maturity in the index at month end. |
Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
| New Issues | Other Bonds Entering | Downgrades | Other Bonds Exiting | |
|---|---|---|---|---|
| November 2021 | ||||
| Count | 8 | -- | -- | 1 |
| Market Value ($M) | $8,431 | -- | -- | $2,468 |
| Market Value (%) | 1.21% | -- | -- | 0.35% |
| 2021 YTD | ||||
| Count | 108 | 41 | 36 | 24 |
| Market Value ($M) | $96,651 | $66,452 | $33,905 | $22,978 |
| Market Value (%) | 11.90% | 13.9% | 4.88% | 3.30% |
Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
Top Yielding Accounting Curve
IRS Curve
Sources: IRS and T. Rowe Price
| Dates | AAA Corporate OAS (basis points) |
AA Corporate OAS | A Corporate OAS | BBB Corporate OAS |
|---|---|---|---|---|
| October Monthly Average | 63 | 45 | 67 | 104 |
| November 1, 2021 | 61 | 49 | 69 | 106 |
| November 15, 2021 | 61 | 48 | 70 | 108 |
| November 30, 2021 | 72 | 54 | 78 | 119 |
| November Monthly Average | 64 | 49 | 71 | 109 |
Sources: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
One-Year Rolling Returns and Tracking Error
| November 2021 Return | YTD Total Return | Annual Tracking Error Relative to Liability | Average Monthly Return Difference from Liability | |
|---|---|---|---|---|
| Hypothetical Sample Plan Liability | -0.81% | -0.40% | NA | NA |
| BBgBarc Aggregate Index | -0.30% | -1.29% | 6.60% | 1.44% |
| BBgBarc Long Credit Index | -0.41% | -0.81% | 4.37% | 0.89% |
| BBgBarc Long Gov/Credit Index | 1.34% | -1.70% | 3.18% | 0.64% |
| Hypothetical T. Rowe Price Custom Benchmark |
0.92% | -0.27% | 2.01% | 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 November 30, 2021.
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 2021, 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 “fixedincome 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
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December 2021 / GLOBAL ECONOMY
Jason DaCruz is a multi-asset solutions analyst in the Multi-Asset Division.
Justin Harvey is the head of Analysis for Multi-Asset Solutions in the Multi-Asset Division. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.