Quantitative easing has led these institutional investors to risk up for survival—and the IMF is alarmed about how they’d weather a sharp correction in rates.
(April 18, 2013) - The loose monetary policies Western central banks have employed to save national economies are pushing pension funds and insurance companies to hazardous risk levels, according to the International Monetary Fund (IMF).
The Washington, DC-based organization released its global financial stability report on Wednesday, which aired concerns about the solvency of these institutional investors in the event of a rapid climb in rates.
Asset-liability mismatches have grown for insurance companies and pension funds since 2008 due to low interest rates, the report noted. While that fact will not come as a surprise to these investors, the IMF's assessment might: Firstly, that the marketplace is not currently pricing in any meaningful rise in rates. A sudden, unexpected US Treasury rate correction is worth considering, the IMF contended, and could destabilize credit markets as a whole.
"A sharp, unanticipated rise in risk-free rates could expose vulnerabilities that are currently masked by low interest rates and ample liquidity," the report said.
For US public pensions and insurance companies in particular, the IMF felt these vulnerabilities are particularly acute. Many have countered rising liabilities and meager Treasury bond yields with leverage (as in risk parity), risk (via emerging markets, for example), and/or illiquid investments (real assets, private equity).
The report further suggested that corporate credit risk may be underpriced—another vulnerability for pension and insurance asset owners. Institutional capital has surged into high-yield bonds recently. Data firm Lipper found that corporate paper was the second-most popular asset class among European investors last year. In 2011, it came in 20th place.
The IMF argued that a rate correction in this asset class could mean a hard landing for investors: "In an environment of rising rates and with greater volatility, rising balance sheet leverage combined with large recent purchases [of corporate bonds] at very low yields and growing margin pressures could prove to be a toxic mix. The result could be forced asset sales (or unforced sales due to valuation losses) that further compound margin pressures and erode capital buffers."
Read the IMF's full report here.
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