MASTERCLASS: Liability Driven Investing - August 2018

Liability Driven Investing has been an investment philosophy that many pension plan sponsors and retirement advisors have embraced to some degree over the past few years. Now, with a flatter yield curve, a return of volatility and a greater need for retirement income, can LDI still provide a solution for future liabilities? In this LDI Masterclass, three leaders discuss the evolution of LDI and where the opportunities lie for 2018 and beyond.

  • Tim Boomer, FIA, FSA - SVP, LDI and Pension Product Manager at Income Research + Management

  • Brad Jacob- Managing Director, Marketing & Client Services at Ryan Labs Asset Management

  • Craig M. Stapleton, CFA, FRM - Senior Vice President, Portfolio Manager at Securian Asset Management

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  • 01 hr 01 mins 22 secs

Sarah: Welcome to Asset TV, I am Sarah Makuta.  Liability Driven Investing or LDI for short has been an investment philosophy that many pension plan sponsors and retirement advisors have embraced to some degree over the past few years.  Now, with a flatter yield curve, a return of volatility and a greater need for retirement income, can LDI still provide a solution for future liabilities? I am joined today by three leaders in the LDI space to discuss the evolution of LDI and where the opportunities lie for 2018 and beyond.  Gentlemen, welcome to Masterclass.  As I said we’re going to talk about the evolution of LDI, Brad, that question’s coming to you first.

Brad Jacob:  Sure.  Well, I think the evolution of LDI really began with the passage of the Pension Protection Act in 2006.  And then that gave plan sponsors a couple of years to educate themselves about some of the nuances of the liability valuation, the corporate bond market and how return objectives might differ and change from more of a total return orientation to something that’s more focused on reducing funding volatility.  And with that we saw plan sponsors assess whether their fixed income portfolios in a shorter duration framework designed to achieve a target of return objective would accomplish the risk management goals that they had relative to funding needs.  So with the Pension Protection Act coming into play I think we saw a shift towards an approach that perhaps is more long duration in nature.  And over time that’s evolved from simply gaining exposure to long duration assets through Barclays Indexes to something that could perhaps be more customized, which I’m sure we’ll talk a little bit more about as we move on the panel.

Sarah: We definitely will.  Tim, let’s talk about Tax Reform, it’s pooled contributions forward, what are the challenges and opportunities associated with the increase in activity?

Tim Boomer: So as you mentioned, Tax Reform did incentivize plan sponsors to bring forward some of their plan contributions.  The reason for that is that we’ve seen a reduction in corporate tax rates.  And that means that those pension plan contributions, for which plan sponsors get a tax deduction, are now going to be lower going forward.  So the answer to that, for a lot of plans is to bring those forward before the September deadline this year.  So they can count them towards the 2017 plan year and take that bigger tax deduction.  We’ve definitely seen that across the board, so probably going back to the end of last summer, we’ve seen an uptake in plan sponsor contributions.  The hard thing is breaking those out from traditional contributions.  So we’ve seen some other drivers in the market for additional contributions such as increasing PBGC premiums, which I know we’re going to touch on more as we go through.  But generally across the board there’s been a lot of incentives for plans to contribute.  And at the same time as this we’ve seen favorable market conditions for a lot of plan sponsors.  And so that combination has really pushed funded status up for a lot of plans, and that’s leading to this uptake in LDI activity.
Sarah:  Excellent.  Do you want to add something there?

Craig M. Stapleton: I do think the 14% tax incentive is a major monetary benefit from an economic standpoint.  But at the same time the markets are robust in valuations on both the equity and the fixed income side.  So there’s a lot of concern that they’re buying at the top on either side.  What I would say, we’re very long in cycle as far as the bull market that we’ve witnessed on the equity side.  Now is the time to de-risk and really take some chips off the table and immunize your portfolio.
Sarah: An update on the PBGC premiums in 2018, do we have any updates to add there?

Tim Boomer: So I really think PBGC premiums have just continued to rise.  I think when Brad talked about the evolution of LDI, I think the other piece as well as kind of the accounting implications and the funding implications, the other thing that we’ve seen is just greater penalties for being underfunded, greater penalties for having volatility on your balance sheet.  And PBGC premiums have been one large driver of that, so they’ve continued to almost increase exponentially.  At the moment this year they are just under 4%, next year they’ll be going just over 4%.  And that’s the variable rate premium, which is the pain point for a lot of plan sponsors.  And so what we saw is that influenced a lot of behavior.  So a lot of plan sponsors can go into the debt markets and borrow money at comparable rates, put that money into their plan and immediately save that 4%.  So we are really seeing that PBGC premium influence sponsor behavior.

Sarah: Excellent.  Brad, do you want to add to that?

Brad Jacob: I agree wholeheartedly with that in that PBGC premiums are going to continue rising per their index rate and as plan sponsors look to de-risk in those, if those costs increase for being underfunded, we’ll see a more appropriate allocation to fixed income based on underlying plan sponsors risk tolerance and risk opacity.

Sarah: Excellent.

Craig M. Stapleton: And we’re seeing a big move into Pension Risk Transfer because it just offsets some of that cost to the insurance companies and you get rid of it, especially with the small balance amounts.  If you’re paying somebody $100, you’re paying a fixed amount per participant, whether it’s $3,000 per month or a $100 per month.  So a huge incentive to carve out those small balances and hand them off to insurance companies.

Sarah: Excellent.  Tim, I’m going to start this one with you, what trends have you seen in the past 6-12 months in terms of LDI activity?

Tim Boomer: So I think, we’ve seen a couple of the reasons why we’ve seen funded status improvements.  And if we look at the average plan, funded status is up about 5% over the year.  And that’s been driven by those market movements by those additional contributions.  And it’s really put us back at levels that we maybe haven’t seen since the end of 2013.  I think the difference this time round is that people are really poised to act on that.  So we’ve already seen LDI activity pick up across the spectrum from very early stage plans who perhaps have been sitting on the sidelines looking for a good entry point.  And we see them using long duration mandates, the STRIPS market, so, ultra-long duration treasury products.  And that market’s been at record levels.  And then going all the way to the other end of the LDI spectrum, those plans that have perhaps been close to fully funded, they’ve seen that, they’ve got themselves towards their end state.  And so we’ve seen an uptake those kind of end game solutions, so Pension Risk Transfer, which I’m sure Craig can hit on more as we go along, or even looking at those low volatility solutions.  So how do we really lock down funded status when a plan’s fully funded?
  
Sarah: Craig, what trends have you seen in the past 6-12 months in LDI activity?
  
Craig M. Stapleton:  Well, plans are in the best financial shape they’ve been in since 2007, with the average plan being over 90% funded.  And the plans have been 90 or 100% funded, they’ve increased their bond allocation by 3-5% last year.  And even on the underfunded side, the 75-90% funded, they increased 1 or 2%.  So dramatic increase in fixed income allocations, more demand for investment grade credit as well, to try to make the most out of their fixed income bucket from a return perspective.
  
Sarah: Excellent.  Brad, how has contribution activity and average funded status changed over the past 12-18 months?
  
Brad Jacob:
Well, I think we’ve seen with the tax law going into effect and plans having till mid-September to take advantage of the new tax rates, we’ve certainly seen an inflow of contributions into pension plans.  And I think overall that’s been a key driver of pension plans funding improving, that coupled with the run in equities that we’ve had has really gotten plan sponsors to consider where we are on the cycle and what tools can we utilize to help further de-risk the plans.  So, we’ve seen those plan sponsors that are still in a core duration type fixed income strategy really reassess if that’s still appropriate for them.  We have seen plan sponsors that are in just a market based long duration allocation, look to assess whether or not something more customized is appropriate for them.  And then finally we’ve seen a lot of plan sponsors who are happy with their 30-40, 50% fixed income allocations start asking questions, “What can we do to de-risk the plan without moving fully into fixed income, but really look to hedge some of the potential?”  I say potential, but the probable tail risk that’s going to rear its head at some point based on where we are in the cycle, and the fact that trees don’t always grow to the sky.
  
Sarah:
Right.  What is the incentive, Brad, for a pension plan to pursue LDI at this point?
  
Brad Jacob: I think we’re at within  the economic cycle with stocks having done their job, within the context of a pension plan’s performance portfolio, leading to funding ratios improving, coupled with Tax Reform Acts that have seen plan sponsors increase their contributions to the plan.  Have really made plan sponsors revisit their fixed income allocations, revisit their overall risk management strategy, and gauging the effectiveness of their current fixed income portfolio and reducing surplus volatility.  And as we approach even further along the cycle, we’re going to continue to see plan sponsors really take a look at the role their fixed income portfolio and look to increase those allocations as their funding ratios improve.
  
Sarah:  Excellent.  Tim, yeah.

Sarah: Craig, describe some of the experience you have with LDI within your firm, and describe how that knowledge could apply to a new market segment?
  
Craig M. Stapleton: Well, I work for Securian Asset Management, which is the asset management arm of a life insurance company.  And if you think about life insurance contracts such as annuities, some of them are very long duration in nature.  Single premium immediate annuities for example are basically pension plans for individuals.  We’ve been managing these and [inaudible] these liabilities for decades.  So this is a risk that we’ve been very good at managing.  We’ve been focused not only on, you know, interest rate risk, but credit risk, liquidity risk.  We build an infrastructure to really backbone this risk management process.  And we can utilize that to benefit pension plan sponsors, and I think that’s to their benefit.
  
Sarah:
Absolutely.  Do you want to go with that question as well?
  
Tim Boomer:  So we’ve … if we go back to the inception of our firm in 1987, our first client was a long duration portfolio for a pension plan that was looking to better align the risks of their assets with the liabilities.  I think the difference back then was that it wasn’t called LDI.  And really we’ve been doing that ever since then.  So we’re a bottom up security selector manager.  We don’t try and predict interest rates, so we practice what we preach in that sense.  And we’ve really found that that’s resonated within the LDI world.  So I wouldn’t say we’re trying to apply to a new segment, I’d say it’s what we’ve been doing really the whole lifetime of our firm.
  
Sarah:
 Excellent, Brad, same question to you.
  
Brad Jacob:  Yeah, similarly we ran our first fixed income strategy versus a custom liability index before LDI was even an acronym going back to 1991.  We’ve always taken the approach that by understanding a client’s liabilities we can better tailor a fixed income bond portfolio to achieve the risk management goals or simultaneously navigating the fixed income market to provide some excess return over that.  And as we’ve evolved and grown as a firm, our ability to offer solutions that can further de-risk pension plans, whether there are various overlay strategies or tail risk hedging, has evolved and we’ve really seen with the Pension Protection Act coming into play, with the economic cycle, [inaudible] plan sponsors funding ratios improved, really at a very interesting time relative to the past 10/20 years that the level of sophistication is higher and the tools that are in place are better and more refined.  So it’s a really interesting time.
  
Sarah:
Tim, I’ll start back with you, as funded status improves and fixed income allocations grow, what challenges does this present for plan sponsors?
  
Tim Boomer: This is a very important question.  So I think as funded status has improved, so we’ve talked about it being up 5% ish year to date for many plans.  The fixed income allocations are growing consistently across the board as plan sponsors look to de-risk out of some of the growth asset classes.  I think if we talk to a lot of the plan sponsors that we work with and a lot of the prospects and the consulting community, a lot of them envisage very late stage portfolios, being the majority hedging assets, which is predominantly fixed income.  Maybe they might have 10 to 20 to 30% in equities in order to keep pace with downgrade immune liabilities.  But predominantly you’re going to see these large fixed income portfolios.  And that really poses a couple of big questions.  So I think the ones we hear most often, “How do you maintain active performance within that construct?”  And the second one is about how you allocate benchmarks across them.  So to address the first one, I think it’s a very valid concern for many plan sponsors if they end up in a … especially larger sponsors, if they end up with a multimanager framework with maybe, 5, 6, 7 active managers in there.  Is there a fear that those active managers might cancel each other’s position?  So if you have multiple managers owning 400 or 500 securities within a portfolio, at what point are you worried about diluting active returns.
  
And we’re a strong proponent that active management becomes increasingly important as your fixed income portfolio grows.  And so the result of that has been an increased focus in how you pair managers.  So a manager like ourselves who’s a bottom up security selector, we might own 150-200 names within our credit portfolio, we might be paired with a larger more macro manager who perhaps uses more derivatives within their strategies.  And so you’ve seen a greater focus on how you pair those.  On the benchmark discussion, we see people talking about whether to have multiple custom managers, whether to break up where you allocate managers across the yield curve, so have some long and some intermediate, or whether to have an overlay manager who quarterbacks the whole process.  I think our view on that is that the more managers you have doing standard processes, generally that’s more efficient for the plan sponsor.  So that can reduce both direct costs and the indirect costs of losing a measurable benchmark.  The other piece of this is that as these fixed income portfolios grow, I think plan sponsors are looking for alternatives to traditional long corporate within their hedging portfolios.  So whether that’s an allocation to securitized or to use a taxable municipal bond portfolio, or even some non-traditional corporate structures such as Century bonds for instance.  So I think people are looking at ways to bring in diversification whilst still maintaining the quality of a hedging portfolio.
  
Sarah: Excellent.  Craig, can I readdress that question to you?
  
Craig M Stapleton: Yeah.  I mean I think you’re absolutely right, Tim, I think there’s a lot of moving pieces here.  And one of the biggest is to make sure that you have a diversified portfolio of managers because you don’t want to have concentration grow with a specific manager with a specific way of investing.  I think also what’s come to light is inflation’s a big concern going forward.  If we do have a rising interest rate environment, more inflation in the market and economy, you’re exposed to that, especially if you have cost of living adjustments within your plan.  So maybe we’re looking more at TIPS and that’s a new strategy for a lot of these plans.  Also doing overlays on derivatives, that’s not something that a lot of the smaller plans have done in the past.  But they’re looking at the duration saying, “Hey, even if I increase my fixed income I can actually reach the duration target that I’m trying to get.  So I need to use derivatives to augment that and minimize the risk of my portfolio.”
  
Sarah:
Excellent.  Brad, I’m coming to you with this one.  What is your philosophy with regard to glide path construction?
  
Brad Jacob:  Sure.  It all comes back to the plan sponsor and what the plan sponsor’s risk opacity and desired risk budget is.  So what we do is we take an approach whereby we’ll quantify where they’re currently at, what their surplus volatility is, what their hedge ratio is, does that get them within the ballpark of where they want to be.  And then as funding ratios do improve, whether it’s a rise in interest rates, whether it’s contributions coming into the plan, whether it’s equities doing their job, whether it’s a plan design change.  What we try and accomplish with our plan sponsors and the consultants that we work with, is having a rules based approach so that all of the work is done ahead of time.  So when these market events occur, behaviorally there is a plan in place and there isn’t a situation where we have to wait for approval to have a board vote on saying, “Yes, we want to increase the allocation by 5%.”  So we can have a seamless approach towards moving along the glide path.
  
Sarah: Craig, let’s talk about your philosophy with regard to the glide path construction.
  
Craig M. Stapleton:  Well, I agree with a lot of Brad’s points.  And we do believe that it should be customized by the clients’ desires.  And we look at what is the risk appetite?  What are they looking for from their portfolio?  What are they comfortable with as far as the risks they’re willing to take?  That being said, we do believe that plans that are underfunded, say 80% funded plan, it probably requires a higher equity allocation, so maybe 50/60% in equities.  Whereas a plan who’s 95% funded we might argue that they only need 25% in equities.  And on top of that, within that equity allocation, they should be looking at what is my drawdown appetite?  And do I need an equity risk management program on top of that equity portfolio as well?  Not just the fixed income, but the equity is a big contributor to the risk of their balance sheet.
  
Brad Jacob:
  And one thing I’d like to add the glide path implementation is it also depends on what the plan sponsor’s ultimate goal is.  If the plan’s going to be ongoing, we’ll take a perspective that the viability of valuation should be maintained along this 100% corporate bond curve that’s in line with how their liabilities are valued for contributions.  But from a completion management perspective, as plans become better funded, as they shift from more fixed income into their asset allocation, will they transfer from a market based approach to something more customized?  And as they approach something more customized, should the liability evaluation reflect something more of a termination approach whereby it’s not just 100% corporate bonds, whereby we’re using treasury STRIPS to price liabilities at the long end so we can be more in line with what the ultimate transition game is going to be.
  
Sarah: Excellent.  Do you want to add about glide path?
  
Tim Boomer:
 Yeah.  I think Brad and Craig hit on a lot of great points there.  And I think I’d definitely echo Brad’s point that there’s the governance side of glide paths is almost as important as the investment side, the fact that it takes some of that second guessing of de-risking out of the equation.  We work with a lot of consultants and a lot of plan sponsors who take very different approaches to glide paths.  We said that one of the trends we’ve seen is maybe a little more around the bifurcation of risks.  So I think the traditional glide paths, which were, back, if you went back four or five years when glide paths really started to be more prevalent.  They were very much equity to fixed income as funded status improved.  And I think what that does is it connects two risks that don’t necessarily go hand in hand always.  So we talk about dialing down equity risk and moving it to fixed income, so at the same time you’re dialing down interest rate risk.  And the two go hand in hand in that glide path.  I think what we’re seeing from some of the consulting community is starting to add additional triggers.  So perhaps where funded statuses dictates equity to fixed income, but where rates are dictate what you do within your fixed income.  So do you have a hedge ratio target in there in each bucket?  And that’s also dependent on where interest rates are at that moment.  So we definitely see them kind of getting a little more granular, but I would definitely say the main selling point is really that governance piece, that it just takes that second guess away.

Sarah:  Let’s kind of get into some of your areas of focus a little bit more.  Tim, we’re going to start with you, what is the impact of recent LDI demand on long duration markets, what has that been?
  
Tim Boomer:  So as a short answer, those markets have coped pretty well, I think.  So we’ve definitely seen an uptake in LDI activity, which has been fairly significant.  And an increase in long duration demand because of that.  However, whilst that’s been happening you’ve actually seen spreads widen in the long end.  So from February tights, we went out about 50 or so basis points, which is pretty significant widening in that demand environment.  I think to really understand that you have to take a step back and look at the broader supply demand dynamic.  So outside of LDI buyers, at the same time as they’ve been coming in, you’ve also seen a slight step away from some of those overseas buyers, and that’s really been based on their currency hedging costs gradually ticking up.  On the flipside, when you look at the supply in the long end, coming into the year I think a lot of us thought we might be looking at supply going down year over year, driven by some of the Tax Reform implications, particularly around repatriation of overseas assets.  What you’ve actually seen is long supply up year over year by about 40 billion.  And that’s been driven by some significant M&A deals.  So I think when you kind of shake those altogether I feel like the supply has really been there to meet the demand so far.  And that’s why we haven’t seen that perhaps driving the long end that we were worried about.
  
Sarah: Excellent.  And, yeah, please.
  
Craig M. Stapleton: I’m actually worried about the supply and demand balance because I’ve seen estimates with the contributions that have come into play as well as the PRT transactions, Pension Risk Transfer transactions.  The estimates are around the $150-250 billion range for this year.  And I think that demand outstrips supply, we’re looking at corporate investment grade issuance that’s $105 billion through June.  So the pension market by itself is pretty much eating up all the corporate bonds that are being issued.  So it’s amazing how that growth spike, and we’re seeing, maybe we need to use more treasuries within our LDI structure, maybe we don’t have enough corporate bonds.  And I think that’s also partly why the yield curve has flattened over the last year.  Last year we had 60 basis point spread between 10s and 30s, now we’re seeing 12 and maybe that is the demand on the 30 year, demand for duration to immunize the liabilities.
  
Tim Boomer:
Yeah.  I would add that, you know, some of that demand, to Craig’s point, has gone outside the long corporate market.  So some of that increased LDI demand has been through [inaudible] STRIPS market where I think we’ve had about 20 ish billion STRIPS activities this year, versus 27 last year.  And last year was a record year so we’re already well on our way to outpacing last year’s activity.  And perhaps we’ve seen some of that flow into the STRIPS market through fears of spreads maybe not being … or through fears that spreads could still widen a little more.  So I think there’s been perhaps some other places for that demand to go this year.
  
Brad Jacob:
 And the one thing I’ll add into that too is, but I think the liquidity challenge that’s represented in the terms of a risk management strategy is actually implementing a fixed income portfolio relative to liabilities.  As we have seen plan sponsors move away from just this pure corporate exposure to include long treasuries.  When they do customize a portfolio and aren’t just looking at this targeted long duration aspect, that opens up the opportunity to play in the securitized space across the front end, which represents a nice diversification in the overall portfolio with corporate like properties, higher yields and a nice total return framework.  But I think overall the grand theme as liquidity becomes more questionable I think plan sponsors are going to have to do, and consultants, are going to have to do a little bit more work to really understand who they’re hiring to manage their fixed income portfolio.  What are the advantages of working with a manager that might be more based in large sector based trades versus a manager that is a little bit more focused on issue selection and what does the size of a manager mean to being able to source bonds?  Is bigger better or is a smaller firm who’s able to navigate the markets a little bit more effectively because their trades aren’t moving the entire market.  Is that an area they can consider?  And then also how do those two types of managers work and interact together.
  
Sarah:
Excellent.  Do you anticipate liquidity challenges in the long term given the potential supply and demand imbalance in the future?
  
Tim Boomer:  Yeah, I think that’s a really great question, something we’ve been asked by a lot of plan sponsors.  And, Craig touched on it slightly earlier, but we have this almost weight of pension demand which we know is sitting around the corner.  It’s almost a when demand, not an if demand.  And that a lot of it has already been committed either explicitly through glide paths to move towards fixed income or implicitly in long term decisions to go to Pension Risk Transfer where ultimately that market, that money might flow back into the fixed income market, or whether it’s to go to these low volatility solutions.  If you look at the relative size of outstanding pension assets to the long corporate market, it’s about twice the size.  So that suggests a heavy weight that could be coming.  I think none of us would say that’s all coming into fixed income, as much as we’d probably all love it to.  But even a small movement in asset allocations brings a significant change with it.  I think so, you know, we kind of think of that demand as pretty certain that it’s coming.  I think the supply side is always the question.  So there’s a school of thought that says supply will always come to meet demand in any market.  However, within the fixed income space you have companies for whom issuing long debt just will never make sense.  So banks and REITs for instance, issues a vast majority of their debt inside 10 years.  And it’s hard to envisage that changing even with a relatively flat yield curve.
  
So overall we definitely envisage some tricky supply demand dynamics.  And we’ve seen plan sponsors try to move ahead of that, so we’ve seen them adding fixed income managers to their lineup, funding up long portfolios ahead of perhaps that feeding frenzy.  And I would echo Brad’s points from earlier that thinking about how managers navigate that space is going to be really important.  So at the moment as a smaller manager we’re able to … the trade sizes are kind of coming to us.  So we’re not needing to buy huge swathes of the market in order to have a significant impact on our portfolios.  So it’s going to be interesting to see where that market goes and how it evolves.
  
Sarah:
 There are a lot of [inaudible] for long duration fixed income benchmarks.  How do you approach benchmark discussions with plan sponsors?
  
Tim Boomer:  So, I think for most plan sponsors the ultimate benchmark is really the plan liabilities.  However, as we’ve discussed previously, that benchmark isn’t necessarily an investable benchmark.  So for many plan sponsors who are focused on accounting results, they’re really looking at a double A corporate universe, and that long double A corporate universe is very narrow in terms of issuers.  So you’re looking at 40 ish issuers, where the top 10 make up the vast majority of the benchmark.  So really we’re thinking about, you need to step away from that universe and make it an investable benchmark.  But at the same time be close enough that on a strategic level you’re aligning yourselves with the liabilities.  In terms of the risks, we tend to think of the risk between the benchmark and the plan liabilities as being strategic risk, that the plan sponsor owns or the consultant owns.  And then we think of the difference between where the managers’ position themselves and the benchmark is more of a tactical risk that the managers are using to outperform.  And where you place that benchmark will determine who owns which of those risks.
  
We also tend to think of the investable universe decision versus the benchmark decision.  So for instance, you might choose a long corporate benchmark as your benchmark but choose the long credit universe as an investable universe.  And that allows a manager to fish in that bigger pool for ideas, but still holds them closer to the liabilities.  A simple example of that might be in the long credit universe you’d see some sovereign debt.  So you’d see issuers like Mexico in there, and the sovereigns make up about 5% of the long credit benchmark.  To the extent you choose your long credit as your benchmark you’re incentivizing your manager with a neutral view on Mexico to hold Mexico.  And that would introduce a strategic risk versus those plan liabilities that are only based on corporate bonds.  If you choose a long corporate benchmark with a long credit universe, now if the manager wants to buy Mexico and they have a positive view on it, they’re going to hold Mexico, they’re going to own that tactical risk and it’s not going to be in your strategic risk at the higher level.
  
Sarah: Excellent.  How do you approach benchmark discussions with plan sponsors?
  
Brad Jacob:  As Tim mentioned earlier, the ultimate panacea is being able to provide return characteristics of a plan sponsor’s specific liability so that they can track the effectiveness of their overall asset allocation and obviously their fixed income portfolio.  But it starts with where the client is currently at.  If a client has invested 30, 40, 50% of their fixed income portfolio the nuances of the bond segment of their asset allocation are such that merely extending duration against a Bloomberg Barclays Index will get them the duration and the credit duration that they need to accomplish those goals.  And as they move further along that’s when we start to see a more customized approach.  However, what we prefer to do, regardless of whether running a core fixed income strategy, long duration fixed income strategy, a custom fixed income strategy is behaviorally always have the liability index as part of the reporting package so they can acclimate themselves with what return characteristics of liabilities are.  And as we’ve moved along the market cycle, and have seen some of the issues with the corporate bond marketplace and the opening up of investment policy statements to include such sectors of securitized bonds and even on a long duration of the curve with the nuances of the long credit marketplace.  Even seeing private fixed income make its way into a portfolio, we’ve seen the evolution of benchmarks really kind of move from that market based approach to the custom liability index.
  
Sarah:
Excellent.

Sarah:  Tim, let’s talk about the pros and cons of Pension Risk Transfer versus hibernation.
  
Tim Boomer:  Yeah, I think this is a great topic.  I mean a lot of plan sponsors are really focused on this, especially given the recent improvements in funded status.  So a lot of plans are really facing this as a real decision now.  They’re in more of a position to talk about going through a Pension Risk Transfer, to talk about how they’re really going to lock down funded status.  I think Craig gave some great insights from the insurance side on this.  I would say that one thing we talk with clients a lot about is having a long term plan and a more holistic plan around it.  So I think there’s often very … the pricing in the PRT world for certain pieces of a pension liability, and there’s more attractive pieces, easier pieces to hedge.  I think plan sponsors also have to focus, not just on the piece that they can offload.  [Inaudible] is the only way to really get out of pension risk, but not just focus on that piece they can offload but also focus on what they are being left with.  So how are they going to continue to invest for the remaining piece with perhaps reduced scale with which to do that?  I also think, we are talking to a lot of plans at the moment who are being … who are now focused on different parts of their pension plan, in particular cash balance plans, are an interesting part.  It’s generally harder to take that piece through a Pension Risk Transfer.  So we’re seeing a lot more interest, and even over the last year or two years around how do you really solve for cash balance solutions in terms of LDI?
  
Sarah:
 And versus hibernation?
  
Craig M. Stapleton: Hibernation I believe is just putting your head in the sand, you’re kind of hiding from the fact that you’re underfunded and you don’t want to write the check.  I mean that’s the pro that you don’t have to write a big check to get you to fully funded status.  With that being said I think it’s the right thing to do.  And once you get to fully funded status you have the option to transfer through a Pension Risk Transfer, if you do it’s a very efficient growing market, it’s growing 20% by count, 20% by market value every year.  More insurance companies are stepping in so it’s, again, tight bid ask spread on this transaction.  And for you as a plan sponsor you get to concentrate less on the markets moving up and down, get it off your balance sheet and you can focus on your core business.

Sarah:  Let’s talk about cash balance pension plans.
  
Tim Boomer:
 So as an actuary I get very excited about cash balance plans, which is probably pretty sad.  But I think cash balance plans are really very unique.  So as we touched on, often the active portion of a plan, so many plans switch their benefit from there over to a cash balance style plan.  There are also often a piece which is more tricky through a Pension Risk Transfer, and they’re harder to hedge.  And really what they are is a hybrid plan between a traditional Defined Benefit final salary plan and between a DC plan.  So when a participant looks at that plan they tend to see it as a DC plan.  So their benefit is defined as a lump sum and it grows every year at the interest crediting rate.  However, for the plan sponsor they see it as a Defined Benefit plan because the actual investment returns don’t necessarily align with the amount they credit to participants.  So the way they value that is to actually project it out to a retirement with an assumption for the interest crediting rate and then they discount it back to today at the double-A corporate rate that we’ve all talked about already today.  So what you end up with is a very interesting balance from a modelling perspective of you projecting at say a 30 year treasury rate or a 3 year treasury rate or however that interest crediting rate is defined and discounting back to today at the corporate rate.
  
So there’s a lot of interplay between those two assumptions and that can throw off very interesting duration patterns and spread patterns in terms of the sensitivities of that liability.  So what we’re really seeing is plan sponsors try and grapple with how do you hedge that?  At the same time as trying to hedge that they have this other goal and their other goal is they have to keep up with that interest crediting rate every year.  So it’s almost like they have a hurdle rate on one side and they have a hedging goal on the other and the two don’t often line up.  So we do a lot of work with plan sponsors on how to prioritize between that goal, how to create some unique solutions to address that, those interesting hedging patterns.  And I really think this is a piece which is going to continue to grow in terms of interest in the market.
  
Sarah:  Excellent.  Brad, did you want to add, or Craig?  Yeah.
  
Craig M. Stapleton:  I think the tricky part is that you really can’t hedge it efficiently.  I mean you have this interest crediting mechanism that increases or decreases with treasury rates.  You can’t buy treasury rates because it’s moving, you know.  You locked in 3% and it goes to 4% or 5% the next year and you’ve less assets because you bought a longer duration asset to back that liability.  So it’s more of a generational investing paradigm where if you have younger workers you have more in equities.  And as they get closer to retirement you move more to fixed income.  So it’s more like a target date, target age type investment strategy.
  
Tim Boomer:
 Yeah.  I think a lot of it comes down to really getting into the weeds of the dynamics of that.  And often it’s even less about the actual interest credit that’s credited and more about how the actuary chooses the assumption, because what you’re really trying to hedge is the interplay of the assumption with the discount rate.  So at least to a lot of conversations between actuaries which I know are riveting for everybody else, but generally it’s really trying to get into the weeds and really understand those liabilities a little more.
Brad Jacob:  What’s also important to understand is the liquidity provision within a cash balance plan or by a participant can pull that, call that liability out in any given day.  So there comes a factor of how do you provide both for that liquidity and also for that return towards that crediting rate?  So typically you’ll see a cash balance plan with shorter duration fixed income relative to a Defined Benefit plan, because there isn’t that long duration kind of known aspect that is hedgeable based on the crediting rate and how that liability is actually paid out.  So we’ve seen liquidity and return and also within that kind of liquidity and return bucket what mix of government bonds versus corporate bonds.  And then what other, as we’ve talked about before, asset classes can become part of that fixed income portfolio to provide a nice balance between the two.  But it’s about quantifying the risk that the cash balance plan does have relative to the plan sponsor, you know, coming up with unique solutions to try and get the right mixture of liquidity assets, return seeking assets, all in a fixed income portfolio, and the grander question related to the overall asset allocation, how much that portfolio will be.  Well, we don’t typically see those cash balance plans upwards of 60, 70, 80% fixed income as a result of the plan design.
  
Sarah:  As an insurance company asset manager probably accustomed to focusing on the fixed income market, against the backdrop of very long dated liabilities, what is your view on the role of equity and alternative asset classes in the LDI framework?
  
Craig M. Stapleton:  You know, it’s much easier with fixed income, you know that you’re investing for the cash flows and liability.  So you need duration or you need to match those cash flows.  For equity it moves around a lot, you have a lot of volatility.  It’s your growth bucket, so it’s the side of your assets that are really generating better returns, hopefully protecting you against inflation, and hopefully increasing your funded status level.  And with that, it comes with a lot more volatility as I said, and you need to manage that.  It’s not something you can just idly hold on to, you need to protect yourself, what are you okay with from a drawdown perspective?  Are you okay going through 2008 again with 50% of your assets?  If not, you need equity risk management on top of that bucket.
  
Sarah: Craig, are you at all worried about equity or fixed income in the next downturn?  And how can plan sponsors protect the significant gains they have already captured within their return generating asset allocation buckets?
  
Craig M. Stapleton:  Unfortunately we as investors often have really short memories as far as market history.  And the reality is we’re long in the tooth as far as this bull market that we’ve had.  And if you look back to all the S&P 500 cycles and look at the returns in this chart of every recovery from a massive drawdown of that, you can see these blue lines end then the black line.  The black line is showing that we are above return profile of all those other recoveries.  Valuations are full and I think if this doesn’t scare you I’m not sure what will.  So everybody should be thinking about their equity bucket, what do I do with it, do I reduce it or do I manage it with some sort of equity risk management profile.  And we could provide overlays to manage the risk to the plan sponsors’ desired outcomes.  Or they could just reduce the equity bucket and take some chips off the table and do more LDI.  I think that’s the biggest market disruption of that that’s going to come.  It’s not a question of if; it’s a question of when.
  
Tim Boomer:  I’d say taking a step back as well, part of the reason why [inaudible] and certainly why glide paths are so important is that people have cashed in some of those chips.  So they put it in place a long term … they put in place a long term plan in order to remove … reduce some of that equity exposure as funded status improved, as equity markets drove them to higher funded status levels.  So I think we’ve seen some of that.  I think in terms of the fears of the fixed income blowup, I know a lot of plan sponsors who would love to see spreads widen.  So most of them are very … are still under-hedged in terms of where the hedge ratio is at.  So for them, spreads widening, although it hurts the fixed income market, actually helps them from a broader level in terms of reducing their pension liabilities.
  
Brad Jacob:  The secular cycle of an equity market, whether it’s a bull market or a bear market typically lasts 12-14/14-16 years.  And within the constructs of those long term secular markets you can have a short term cyclical market, meaning that the S&P has rallied since the spring of 2009.  It’s now the summer of 2018.  So if you want to make the argument that this secular bull market started in 2009, at the very least we’re due for a cyclical pullback.  You can also make the argument that the secular bull market started after the tech bubble in 03, which would bring us to around the 15 there, whereby the credit crisis was certainly a meaningful drawdown.  But within that long term nature that could be viewed as a major cyclical bear market.  But where we’re at right now we know that we’re at the tail end of some semblance of an equity rally.  So it becomes important as it relates to the role of equities versus fixed income and alternatives, is that the concentration of tail risk exposure in a pension plan’s portfolio is in the equity portfolio.  So how can we as service providers, develop solutions that can do our part in trying to give the plan sponsor their cake and having them eat it too?  So it becomes an aspect of what overlay strategies can be built into the portfolio that are dynamic in nature, that can assist in being a buffer against an equity drawdown.  And also the role of long treasures in an LDI framework when we’re at the time in the cycle that we are, being the one asset class that will certainly hold its ground during an equity pulldown.
  
Craig M. Stapleton:  And I think there’s way too much fear about fixed income and interest rates.  I think it’s overplayed by a large degree; demographics are a big driver here.  A lot of people are retiring now, baby boomers, so you have more natural demand for fixed income assets.  And with that we don’t have a lot of acceleration of spending; millennials have been flat as far as their earnings for decades now.  So we really don’t have the demand to really create the inflation or create the growth that will create the higher interest rates.  So I think it’s overplayed.  And I think, you know, it would be surprising to me if we have a dramatic increase in treasury rates, whereas it wouldn’t be surprising if we see a big drawdown in equities.
  
Sarah: Tim, we’re coming to you with this one.  When do you see value in developing custom LDI solutions versus utilizing more traditional benchmarks?
  
Tim Boomer:  So I think when we think about the risks affecting a pension plan, in terms of interest rate risks, we view it in the similar context to how we view the risks affecting a portfolio of high quality corporate bonds, because that’s the basis for the discount rate that they’re often concerned with.  And so when we think about those risks, broadly we think about duration, credit and curve.  So duration being parallel shifts in interest rates, credit being a movement in credit spreads, and curve being those non-parallel shifts at the end.  We tend to try and approach them in that order of magnitude, so duration generally drives, especially in a low rate environment, the majority of risk.  Credit provides another portion of the remainder and curve tends to be this very little piece on the end.  And we all tend to rush towards curve in the LDI space because it’s definitely the most glamorous thing in LDI and that’s where you see the real custom solutions.  For early stage plans they’re generally concerned with addressing the broad duration mismatch.  So generally they might have a large allocation to equities, be under-allocated to fixed income, and they’re really just trying to make that fixed income portfolio work as hard as it can.  And normally you can do that with standard benchmarks, whether that’s a traditional long corporate, long credit, long government credit, whether it’s utilizing some of the other instruments we talked about, so treasury STRIPS.  You might see some customization in terms of derivative usage for plans that are more comfortable with that.
  
Then as you progress and you start to think about credit risk as you get better funded, you see more of a focus towards those long credit, long corporate mandates.  You may see some customization in terms of high quality focused mandates.  But we still think there’s very valid reasons to be investing in a full investment grade credit universe.  And finally in that late stage where you really get into those curve solutions, that’s where you see customization start to take hold.  For most plans here you’re talking about very well-funded plans, significantly allocated to their hedging portfolios and really having locked down the vast majority of duration and credit risk.  However, even in that bucket there’s very different ways to approach it.  So cash [inaudible] matching where you’re aligning the payments from your bond portfolio with your pension liabilities can often be almost a spurious accuracy to what you’re doing.  So from a modelling perspective it feels very nice.  But if you talked to our traders they would tell you that a 13 year bond versus a 14 year bond trades exactly the same.  And even when you go further out on the curve, a 20 year bond versus a 30 year bond trade very similarly.
  
So trying to get too accurate can often be misleading.  It can also introduce costs, so not just the direct costs, having a more complex solution, but the indirect costs of missing out on some of those good opportunities that you might otherwise be able to fit in.  So even in those kind of late stage curve matching portfolios we’ll tend to approach it from a key rate matching perspective where we’re bucketing the exposures into different buckets along the yield curve and trying to match them more broadly, which still allows us to get our best ideas in the portfolio.  Because ultimately you need that active return to keep pace with the liabilities as they’re immune to downgrades and defaults.
  
Sarah:  Excellent.  Brad, same question to you.
  
Brad Jacob:  Yeah.  As it relates to customization versus market benchmarking, like so many conversations in the LDI universe, the answer is it depends.  It depends on where the plan sponsor is at on their asset allocation or exposure to fixed income.  It depends on where they’re at on their glide path; it depends on where they’re at in their termination goals.  It depends if they are ongoing in nature, it depends on their funding ratio.  So the way we kind of break it down is that for those plan sponsors that are still worried about the return portfolio and one exposure there, a market benchmark can do its jobs in getting their head ratio up to a 25/30% range with, well, a market long duration benchmark.  And that works well, especially when you look at the hedging characteristics of a long credit, a long corporate bond strategy relative to movements in the PPA yield curve, it does the job.  Similarly, a gov credit long strategy, it does the job of hedging to the degree that pretty much a custom portfolio can if your allocation is sitting around the 30/40% fixed income range and your plan is funded at 70, 75, 80%. As plan sponsors move along that glide path as their funding ratios become higher, they are looking to lock that in.  And relative to curve fit, relative to where spreads are at, relative to how much more effective a custom strategy can be when you are at that range of 60, 70, 80% fixed income, and reducing surplus volatility to the tightest range possible from a physical bond portfolio before getting into some of the derivatives and overlay tools that do exist.  That is really where the conversation leads to with plan sponsors, so we’ve seen implementation across the board.
  
Craig M. Stapleton:  I agree with Brad, I think it’s a spectrum of solutions.  It’s not as if you’re going to start at the 60/40 simple portfolio and jump to a curve matched, [inaudible] duration matched fixed income portfolio.  So it’s a transitory stage and depending upon how far you are in de-risking spectrum, I think one of the things that you really should focus on with your client is what is the risk appetite on the credit side, sit down and say, “How much do you really want in triple-B’s, do you want a lot in double-A’s, do you want treasuries, government securities?  Do you want to sleep better at night or do you want to add 50 basis points of return moving down the triple-B’s versus single-A’s?”  Those are real economic decisions and there are those sleep at night questions, you know, that you need to answer for yourself.  And we help you kind of manage through that thought process.
  
Sarah: Okay.  When to implement, what to consider, how often should plan sponsors monitor the glide path.
  
Brad Jacob: I think for those plan sponsors that have yet to implement LDI, now certainly represents a very compelling time to at the very least review the effectiveness of their current asset allocation and their risk management goals.  So what does that mean?  That means that if they are in a shorter duration fixed income strategy, if they are in core fixed income versus something long duration, is that aligned with the overall risk opacity of the plan sponsor?  Does that align with the risk, budget goals and the behavioral profile of the plan sponsor?  We have some pension plans that are 75% funded, that are 80% fixed income and fully customized because their plan sponsor does not want to deal with a single downturn and have a contribution strategy in place.  Similarly we have plans that are 110% funded, that are ongoing in nature that have a parent company, that is hugely profitable, they feel the equity rally is going to continue to run and they don’t want to de-risk yet.  So they’re 25% fixed income.  So it really becomes, where you’re at as a plan sponsor relative to where we’re at in the market cycle and have the conversation and quantify the risk management characteristics of your bond portfolio.  Is it getting you there?  Is your interest rate hedge where it should be?  Is your tracking error of the portfolio where it should be relative to your liabilities, is your surplus volatility?  Are your tails tightened to the level where a business isn’t going to have to make difficult decisions whether money is going to go into their pension plan versus an acquisition or another project?  So all of these conversations come into play when we’re looking at the decisions of when it’s time to implement what they should consider.
  
Sarah: Let’s talk about LDI strategies, let’s talk buy and hold versus active.
  
Brad Jacob:  Sure.  I think for the majority of pension plans that are in early stage LDI going through up until maybe a year or so before they were looking to terminate, active management becomes a very key driver of success of the LDI strategy.  There’s many nuances of the fixed income market.  And I think plan sponsors want to have a team in place, a team of portfolio managers, of analysts that can monitor their portfolio every day, make decisions as to how the portfolio should be structured relative to their index, relative to whether it’s a market benchmark or a custom liability index.  That are having the conversation of the value of triple-B’s versus single-A’s and whether or not the risk reward characteristics of that segment of the bond market is appropriate.  I think as plans move closer to termination, a buy and hold strategy becomes a little bit more compelling for the risk transfer agencies who want to see the bond portfolio line up as closely with the liabilities.  When they give you that preliminary valuation of your liabilities they like to review where the portfolio is sitting relative to those liabilities, while still understanding that from that point in time where a liability is priced versus when it’s ultimately terminated, there’s still nuances in the marketplace that you want your portfolio to manage.  But I think prior to getting to that point, an active management framework within your LDI strategy is certainly going to provide a little bit more value add relative to a set it and forget it type approach.
  
Tim Boomer: Yeah, I would add as well that it’s also not necessarily a binary decision.  So even in, when we think of as a buy and hold portfolio, the interface buyer maintains sometimes.  So it’s almost like an active light in that sense, that perhaps you’re no longer so concerned about downgrades because … or, sorry, you’re no longer concerned about a downgrade in credit risk.  You’re more concerned about just will you get paid.  So perhaps you might take a slightly different active philosophy within those portfolios but you still might be going through them and combing it out for potential defaults that you don’t want to bear the brunt of in your fixed income portfolio.
  
Craig M. Stapleton:  Yeah, I would add, I mean the focus is really to try to cash flow match.  And if you’re trimming the portfolio very quickly or rapidly it’s hard to achieve that, that’s one aspect.  The other is that there’s a lot of research out there that’s shown active managers in the fixed income universe have outperformed.  There is some alpha that can be generated.  If you think about indices, an index, say IG Index, if a credit falls from a triple-B it becomes a fallen angel and goes to a double-B, it falls out of the index, yield goes down in the benchmark, and you sell that security at a higher spread at a loss, is that the right thing to do?  If you’re an active manager you’re looking at that credit and saying, “This is temporary, this is a good bond, good company, good credit, we’re going to hold it.”   And there’s value there.  And on top of that on a daily basis we’re doing relative value.  We’re looking at different, you know, securitized versus corporate, or agency mortgage backed versus municipals.  We have the ability to make those shifts on a timely basis, or A’s versus triple-B’s.  So I think there’s a lot of value add that you do need to look at active managers to generate that.
  
Tim Boomer: Yeah, especially when you consider that the liability benchmark, as those bonds get downgraded they drop out of the liability benchmark and the liabilities recover immediately.  So you’re almost always facing this headwind and active management is one of the key ways to combat that as well as diversification into some of those other sectors.
  
Brad Jacob:  Similarly, the argument for active management versus passive in the fixed income portfolio, it’s different than the equity portfolio in that the indexes are different.  You can passively buy the components of the S&P 500, you can’t passively buy the components of whether it’s the Aggregate Index, whether it’s a long credit index, you’re typically going to hold a couple hundred names in that portfolio.  In those passive strategies, whether it’s a core fixed income portfolio, there is typically 8,000-9,000 names in that index.  And the passive managers are trying to purchase whatever they possibly can just to have every name in that portfolio, that they still can’t buy.  So even passive strategies are actively managed to a small degree, but it becomes do you have the team in place to really monitor the risks associated with the underlying names that are in your fixed income portfolio which becomes a much more compelling argument for the role of active fixed income overall and in a risk management framework.
  
Sarah:  Excellent.  Are there any risk management alternatives?
  
Brad Jacob:  Yeah, I think overall in an LDI strategy, the physical bond portfolio makes up the core component of your risk management strategy.  But as markets evolve, as solutions are brought to the table there are things that plan sponsors can be considering in the derivatives and overlay space.  In the makeup of their fixed income portfolio, should they look at a securitized component within the LDI portfolio, is there a role for long duration private fixed income in the portfolio?  And then a conversation we’ve been involved in, and I venture to say everyone at this table has been involved in is relative to de-risking and where we’re currently at in the equity markets. where plan sponsors still want exposure to those growth assets.  But they don’t want the pain that will be associated with that exposure if and when that downturn hits.  So we’ve seen an increase into tail risk hedging strategies and reviewing tail risk hedging strategies and how the structure of that type of hedge, whether static in nature or dynamic in nature should really be incorporated into the fixed income portfolio.
  
And I think as that conversation evolves, we’ve seen plan sponsors understand that static hedge.  Whether that’s always buying out of the money S&P puts, becomes a costly drag on performance versus ways that you can look to maybe dynamically add duration to the portfolio, not necessarily in a pure market timing standpoint.  But in a framework where you’re assessing everything that’s going on in the underlying economy and whether or not it makes sense to put on some type of overlay trade that could help reduce the drawdown that will eventually occur in the equity markets.  And I think the return of volatility this year certainly have been the catalyst for a lot more of these types of conversations than we’ve seen over the course of the past 2, 4, 6 years.
  
Craig M. Stapleton:  And like everything else we’ve talked about, it’s a spectrum of options and on the equity management it could just be simple buying puts to protect your portfolio, it could be a dynamic, you know, we do overlays with dynamic managed volatility, increasing, decreasing equities based upon research that we’ve done.  There’s a big, big shift in the way the market’s looking at equity risk and I think there’s an opportunity for everybody to get more educated about what the options are, dig into them, feel which one’s the right solution for you.
  
Sarah:  Brad, coming to you, with the increasing trend toward customization, how do you measure success?
  
Brad Jacob:  I think success of a customized strategy is measured against what that strategy is customized to.  And in the context of a pension plan, it’s how is a bond portfolio customized to your liabilities?  Is your bond portfolio hedging interest rate risk as it’s designed to?  Is your portfolio reducing tracking error relative to your liabilities?  And I think most importantly is your bond portfolio doing its part in reducing the overall surplus volatility of the asset allocation relative to the plan sponsors’ overall goals for their entire portfolio of assets relative to their liabilities.  And then breaking that down even further, for the bond manager, that becomes a component of are you outperforming the Liability Index or not?  Because there is an active component to the strategy, you want to see your bond manager outperform their benchmark if they’re being hired to do that.  Is the volatility of your bond portfolio relative to your Custom Liability Index, in line with your risk management goals?  And then all the pieces of the puzzle come into play relative to your glide path.  Is the bond portfolio doing its job in providing a foundation to de-risk the plan and are you successfully moving along the glide path as funding events occur?
  
Craig M. Stapleton: Well, I think Brad made a lot of great points.  And the only thing I would say is you really do need to sit down with the client and figure out what is their objective, and what is their comfort level around certain risk parameters.  What kind of funded status volatility do they want?  You know, what kind of equity risk are they willing to tolerate, what kind of credit risk?  You document those and then it’s easier to document are you meeting those desired outcomes.  If you don’t have that set up, you know, beforehand everybody’s going to be pointing fingers and saying, “You screwed up or you screwed up.”  So it’s really just about that consultative approach with the client, that’s the important piece, then you can regularly talk about if those objectives are being met or not.
  
Tim Boomer:  Yeah, and I’d echo those points.  I think really the measures have changed, it’s gone away from that total return framework to talk more about the impact of the fixed income portfolio, in our case, on the broader hedging strategy and on the glide path.  I think that the consulting community and the plan sponsor community are also bringing those measures to us.  So, increasingly it’s not about did we add alpha, it’s about how did we add alpha, and did we add it in a way consistent with how we said we were going to add alpha?  So I think it’s, you know, there’s just more nuanced detail into the drivers of returns, the drivers of volatility across the board.  And we’re seeing people generally think about this in a more holistic way.

Sarah:  What is your firm’s competitive edge in this LDI space?
  
Craig M. Stapleton:  Well, Sarah, it’s obvious that we’re great credit managers, I don’t need to talk about our fixed income active management capabilities, performance speaks for itself.  But beyond that, we’re consultative; we’re here to work as Tim said, with you, from where you are to where you want to get to.  And if you actually want to get to a buyout, we’re agnostic, we’re an insurance company, we could be the insurance company who takes your assets and we’d be happy to do it.  On the fixed income side we can create customized approaches for small plans.  If you’re less than $25 million you’re not getting a lot of custom approaches out there, a lot of naïve fixed income allocations.  We can do that on a customized basis for you.  And on top of that I think we have a very, you know, compelling managed volatility story, I love to get out there and talk to the clients, you know, and say, “What do you want for risk appetite?  What kind of drawdown are you comfortable with?”  And we’ll create customized equity overlay that achieves that in a very smart dynamic way.
  
Sarah: Brad, what is your firm’s competitive edge in this LDI space?
  
Brad Jacob:  Our firm was founded under the premise that a pension plan’s risk management goals would be better accomplished with a fixed income portfolio that was tailored to meet very specific objectives.  So whether that’s a long duration strategy managed against a Bloomberg Barclays Index or a fully customized strategy, we’ve been doing this since 1991, we’re a top decile and quartile fixed income manager when you look at our performance across the curve.  In addition to that our infrastructure has been built to provide these solutions.  So from a reporting and risk management characteristic and standpoint we have an ability to manage a portfolio on a daily basis versus a custom liability index and push those reports to a plan sponsor to better manage and monitor their glide path.  And similarly as we’ve grown and evolved, we were acquired in 2015 by Sun Life and that has fully expanded our platform to not just physical bond portfolios but an overlay team that has experience going back to the mid-80s in managing derivative and overlay strategies.  And with the combination of physical bonds, active management, and a total return framework relative to a risk management goal and various hedging strategies we feel that we’re very well positioned to provide a level of service to the plan sponsor and consultant community that our peers oftentimes aren’t quite able to provide.
  
Sarah: Tim, what is your firm’s competitive advantage in the LDI space?
  
Tim Boomer:  Since our inception 30 years ago our first client was a pension plan sponsor who we were managing long corporate fixed income for in order to better align with our liabilities.  And that’s really been kind of one of the core aspects of our business.  We’re a bottom up fixed income investor, we don’t believe in trying to predict interest rates, all our portfolios are duration neutral and that’s really a practice what we preach approach to LDI.  And we’ve really seen it resonate.  At 70 billion in assets under management we really think we’re in a sweet spot in terms of we’ve built out the solutions for those very custom late stage mandates, we have the back office that we need in order to operate in this space.  But at the same time we’re still nimble enough to execute our bottom up strategies and ultimately get the best bonds into our clients’ portfolios.  We really try and look to partner with our clients.  There’s a lot of often over-complication in the LDI space and we really try and take a practical approach, so we focus on the biggest risks and the biggest drivers of volatility at any one point and try and address those.  And really we try and partner across the consulting and plan sponsor spectrum to ultimately help plan sponsors get to their long term goals.
  
Sarah:  Excellent.  Gentlemen, this truly has been a fascinating conversation, a lot of information you’ve thrown on me as well, I think this is fantastic.  We are coming to an end; let’s make our closing remarks here.  Craig, give us your final thoughts here for our audience to take away.
  
Craig M. Stapleton: I think this is an exciting time to be in the LDI universe, there’s a lot of rapidly moving pieces and we’re here to help you.  I think we can sit down and come up with a customized solution to get you from where you are to where you want to be in a very smart and strategic way.  And we’re looking forward to that conversation.
  
Brad Jacob: I think the return of volatility has brought with it a very opportune time for plan sponsors and consultants to revisit the conversation and review the effectiveness of their current fixed income portfolio and asset allocation relative to the designated risk management goals of a plan sponsor.  Take a look at your glide path, take a look at the makeup of your fixed income portfolio, review the types of strategies that are out there and the types of investments that can be a part of the LDI strategy, from physical corporate bonds to long treasuries to securitized bonds to long duration private debt and various overlay strategies.  The entire pack is what it’s going to take to effectively move along your glide path and de-risk your plan to get to the point where you’re trying to get to.
  
Sarah:
Excellent.  Tim.
  
Tim Boomer: Yeah.  No, I’d say I think one thing probably to take away is that there’s a lot of different approaches in this space.  But there’s a lot of similar challenges across the board.  So I think plan sponsors are all dealing with the same drivers, the same incentives to contribute to their plans, whether that’s PBGC premiums or that’s Tax Reform.  And as this money’s flowing into this space, it’s definitely a time to review how you’re allocating it, whether that’s for larger plans with multi manager frameworks and thinking about how your managers pair up in that space or whether it’s some of those plans that are getting towards the late stages and rethinking about the next steps, whether that’s Pension Risk Transfer or it’s looking to lock in funded status volatility a little more.  So I think it’s just a really busy time in the LDI space and it’s a very positive sense, because plan sponsors are really getting to grips with the drivers of that volatility and how to approach it.
  
Sarah:
Excellent. Well, gentlemen, thank you so much for being here today. And thank you for tuning in, I’m Sarah Makuta and this was the LDI Masterclass.