Beware the End of the Glide Path

(June 3, 2013) - It may be now or never for defined contribution (DC) plans to shift out long-duration fixed income, consultancy Casey Quirk warned in its latest whitepaper.

The Connecticut-based firm projected a $1 trillion shift out of treasury bills and other traditional bonds, based on growing unease over interest rates. Defined contribution retirement accounts hold roughly a quarter of their total assets ($1.2 trillion) in fixed income. If rates rise to half of their historical average, or 4.1% for 10-year treasury bonds, the paper's author Yariv Itah estimated DC plan losses to top $180 billion.

In the event of a rate hike, target-date fund strategies would exacerbate losses for DC plan members nearest retirement. Glide paths derisk over time, largely by swapping equities for "safe haven" long bonds, despite the historically low rates of the past five years.

Short duration credit and high yield were the real safe havens in Itah's model, showing the most moderate value swings from changing interest rates. 

On the opposite end of the spectrum, a portfolio of long duration, high-grade fixed income would gain 24% with a zero rate environment, according to the analysis. But, the paper pointed out, with rate volatility, downside potential far outweighs upside. That same portfolio would lose 40% of its value if interest rates climbed to 4.1%.

Traditional fixed income managers have grown complacent (and often rich) over three decades of fairly steady and downward-trending rates, he argued, leaving the market unprepared to manage rate instability.