Interest rates around the world are near record lows, and with the Eurozone economy officially in contraction, they don’t appear set to climb anytime soon.
What’s a CIO to do? Invest in alternative fixed-income (i.e. timber land, infrastructure, and high-yield bonds), emerging market debt, absolute return bond funds, and long-duration bonds, according to Ashish Kapur, fiduciary manager SEI’s head of European institutional solutions. Kapur recently published a whitepaper on the future of interest rates and strategies for maneuvering through a higher or lower rate environment. With the news of Europe’s shift from stagnation to contraction, the former situation doesn’t seem worth fretting too much about.
“It is quite conceivable that the situation could worsen before it gets better,” wrote Kapur. “Further falls in interest rates would of course mean higher liabilities for pension schemes.”
To cope with the volatility of fund liabilities, Kapur suggested setting de-risking triggers to manage interest rate hedges. “These triggers can be funding level related whereby switches are made according to changes in funding level or market related in which switches are made according to pre-agreed market changes,” he explained in the paper. Triggers can be automatic or manual, whereby the pension scheme is consulted every time a trigger is reached before a change is made. “The specific triggers will differ by pension scheme according to their funding value and risk appetite,” he wrote.
Kapur called the timing of a rise “impossible to predict,” and listed the conventional factors that could lead to a rate jump: a resolution to the Eurozone crisis, high inflation, and growth in the US, United Kingdom, and emerging markets.
In July, Pacific Investment Management Company CEO and co-CIO Mohamed El-Erain argued that low global interest rates were hurting institutional investors without boosting economies. “According to textbook economics, lower interest rates have beneficial flow and stock effects. They make it cheaper to fund investment and consumption; and they make it easier for companies, governments and individuals to carry a given stock of already-accumulated debt,” El-Erian contended. “In practice, however, the situation is much more complicated and not so benign.”