PIMCO: Papers Focus on Delayed LDI, US Credit Outlook

(January 3, 2012) — Two separate papers published by the Pacific Investment Management Co. (PIMCO) comment on delayed implementation of liability-driven investment (LDI) and on the future of America’s triple-A credit rating.

A piece published by Rene Martel, executive vice president and product manager in PIMCO’s Newport Beach office, explores the implications of delayed implementation of LDI, claiming that plan sponsors that are in a waiting mode to pursue the strategy should consider switching to long duration portfolios with a synthetic overlay in an effort to reduce duration exposure. “With interest rates so low, many defined benefit plan sponsors have delayed implementing or expanding LDI programs, often using intermediate duration bond portfolios instead,” Martel asserts, adding that waiting for higher interest rates before extending the duration of fixed income portfolios to better match liabilities is often presented as a strategy that is almost guaranteed to pay off.

According to the paper, given the significant amount of uncertainty over the timing and magnitude of future interest rate increases, exploring alternatives to traditional intermediate duration bond portfolios may provide a significantly higher yield and a better fit to the spread exposure embedded in pension liabilities valuation. In addition, it may help the sponsor avoid competing with many other investors to buy long-dated corporate bonds, Martel notes.

Read aiCIO’s Liability-Driven Investment focused issue here. 

On the topic of the United States’ credit rating, Mohamed El-Erian, PIMCO’s chief executive and co-chief investment officer, notes that “this public good is…difficult to value holistically or to sustain properly.”

He continues: “America’s triple-A rating is vulnerable. Two of the three major rating agencies, Moody’s and Fitch, have given it a ‘negative outlook,’ signaling real possibility of a downgrade in the next two to three years. Standard & Poor’s downgraded the US credit rating late last summer in the context of the debt-ceiling debacle and, adding insult to injury, placed the nation’s lower, AA-plus, rating on review for possible downgrade.”

According to El-Erian, further harm to America’s credit would be detrimental to the global economy, further undermining the legitimacy of multilateral institutions. Looking ahead, he notes that “maintaining the US credit rating should figure prominently among the new-year goals and resolutions of Congress, the administration and Washington’s bureaucracy.”