November 2022 / INVESTMENT INSIGHTS
Pension Curve Insider: LDI Solutions October Monthly Recap
October 2022
Monthly Recap
The Federal Reserve continued to tighten monetary policy during the month of October, raising its policy benchmark by 75 basis points. As rates markets adjusted to expectations of higher rates, the Treasury curve inversion deepend to its most negative legal year-to-date. Amidst the broader market volatility, credit spreads widened through the month.
Plan liability values decreased on a marked-to-market basis in September, extending their decline from August. Discount rates for a sample plan liability increased by 86 basis points based on the AA-rated spot curve and 76 basis points using the top-yielding curve. At month end, the top-yielding curve provided 32 basis points of additional yield versus the broader AA-rated universe.
Issuance was modest during the month, as eight new bonds with $6.8B of notional value entered the index. Maturities and index eligibility were the only reasons for outgoing turnover. New entrants had a small downward impact on the medium- to long-term segment of the AA-rated spot curve, while exits had a negligible effect overall.
Liability Impact
| Yield Curve | Liability Value 9/30/22 |
Discount Rate 9/30/22 |
Liability Value 8/31/22 |
Discount Rate 8/31/22 |
Liability Value 12/31/21 |
Discount Rate 12/31/21 |
|---|---|---|---|---|---|---|
| Accounting Yield Curve |
$8,429 | 5.32% | $9,405 | 4.46% | $11,849 | 2.82% |
| Top Yielding Accounting Curve |
$8,107 | 5.64% | $8,913 | 4.88% | $11,192 | 3.21% |
| IRS Yield Curve | $8,455 | 5.26% | $8,756 | 4.99% | $11,411 | 3.06% |
Sources: Bloomberg. 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. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
| Issuer | Event | Curve Impact |
|---|---|---|
| WalMart Inc. | New Issue (4 Bonds) |
WalMart Inc. issued $5.0B notional of debt through four issues, with maturities ranging from 2025 to 2052. All four issues traded tighter than comparable peers, and had a small downward impact on the AA-rated curve. The American retailer was the fifth-largest issuer of the AA-rated universe and accounted for $21.2B of debt at monthend. |
| Export-Import Bank of Korea | New Issue (3 Bonds) |
The Export-Import Bank of Korea brought three new issues to market during the month of September. The issues priced tighter than similar bonds, but only had a negligible downward effect on the short- to medium-term segments of the AA-rated curve. |
| Oesterreichische Kontrollbank AG | New Issue (1 Bond) |
Oesterreichische Kontrollbank AG (“OEKB”) sold one five-year bond in early September, with notional value of $1.0B. The new issue of the Austrian export bank traded tighter than peers and had a minor downward impact on the medium-term segment of the AA-rated curve. |
Sources: Bloomberg. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
| New Issues | Other Bonds Entering | Downgrades | Other Bonds Exiting | |
|---|---|---|---|---|
| September 2022 | ||||
| Count | 8 | 0 | 0 | 3 |
| Market Value ($M) | $8,261 | - | - | $3,479 |
| Market Value (%) | 1.51% | - | - | 0.64% |
| 2022 YTD | ||||
| Count | 59 | 11 | 9 | 5 |
| Market Value ($M) | $50,093 | $11,546 | $5,683 | $61,236 |
| Market Value (%) | 9.16% | 2.02% | 0.99% | 11.2% |
Sources: Bloomberg. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
Top Yielding Accounting Curve
Sources: Bloomberg. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
IRS Curve
Sources: IRS and T. Rowe Price
| Dates | AAA Corporate OAS (basis points) |
AA Corporate OAS | A Corporate OAS | BBB Corporate OAS |
|---|---|---|---|---|
| August Monthly Average | 108 | 66 | 107 | 167 |
| September 1, 2022 | 101 | 65 | 113 | 174 |
| September 15, 2022 | 100 | 70 | 111 | 168 |
| September 30, 2022 | 119 | 75 | 129 | 188 |
| September Monthly Average | 105 | 69 | 116 | 174 |
Sources: Bloomberg. Bloomberg Index Services Ltd. Copyright 2021, Bloomberg Index Services Ltd. Used with permission. T. Rowe Price.
One-Year Rolling Returns and Tracking Error
| September 2022 Return | YTD Total Return | Annual Tracking Error Relative to Liability | Average Monthly Return Difference from Liability | |
|---|---|---|---|---|
| Hypothetical Sample Plan Liability | -10.00% | -26.8% | - | - |
| Bloomberg Aggregate Index | -4.32 | -14.62 | 6.76% | 1.47% |
| Bloomberg Long Credit Index | -8.64 | -29.05 | 4.40 | 0.91 |
| Bloomberg Long Gov/Credit Index | -8.30 | -28.94 | 3.22 | 0.64 |
| Hypothetical T. Rowe Price Custom Benchmark |
-7.05 | -24.28 | 2.17 | 0.35 |
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 September 30, 2022.
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 2022, 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
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass.
The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
It is not intended for distribution to retail investors in any jurisdiction.
USA – Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.
© 2022 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.
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.
