SEI: Even Lower Interest Rates ‘Quite Possible’

SEI's Ashish Kapur won't predict when interest rates will rise, but advises institutional investors to ride out the low rates through allocations in long-duration bonds, emerging market debt, and high-yield bonds.

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.

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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.”

(August 14, 2012) — Amid a dire fate among the defined benefit (DB) market, closures of such plans in the United Kingdom are actually slowing, according to a survey by Greenwich Associates.

A total of 12% of all those surveyed anticipate closure to future accruals within the next two to three years. In comparison, 15% of those surveyed two years ago said they expected closure.

Meanwhile, Greenwich’s 2012 UK Investment Management Study of 353 senior professionals at a range of institutional funds — conducted from January through March — found that the life of the average DB plan is about 35 years.

The study discovered that among corporate plan respondents, 24% said they’re likely to up their exposure to active fixed-income strategies. At the same time, 14% said they plan to heighten their allocation to passive fixed-income.

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The study by Greenwich Associates follows a study by consulting firm Aon Hewitt last November, confirming a continued trend of closure to DB accrual among UK schemes. “Just over 40% of the schemes surveyed have either already closed to DB accrual or are currently in the process of closing to future accrual,” James Patten, benefits design specialist at Aon Hewitt, said in a statement at the time. “Nearly half of those that have closed to accrual, and indeed many of those that have not, are now taking pension risk management to the next phase. In some cases, this might simply be through implementing a liability management exercise such as an enhanced transfer value offer.”

Patten continued: “However, in an increasingly uncertain economic environment, we are seeing more schemes trying to take this concept a stage further. A growing minority is considering, or indeed implementing, ‘flight plan’ strategies to chart a course for reducing pension risk exposure at appropriate times, and/or ultimately fully settling their liabilities with an insurance company.”