When Rates Rise, How Might Your LDI Strategy Fare? | Capital Group

Investment Insights

January 2016

When Rates Rise, How Might Your LDI Strategy Fare?

The Federal Reserve has finally begun its move away from its near-zero interest rate policy, and many plan sponsors may expect interest rates to rise further. From an LDI perspective, what should you do if and when rates rise, and discount rates increase accordingly? This, it turns out, is a simple question with a far-from-simple answer. Interest rates can go up for a variety of reasons. The economic backdrops in which liability discount rates may rise can be surprisingly different and, consequently, so can the behavior of asset prices.

Of course, the future is unknown, so a sensible approach is to consider some different hypothetical scenarios and explore how an LDI strategy may fare in each one.

Here, we construct scenarios with the help of an econometric model. Then, we use Monte Carlo analysis to develop a strategy designed to be optimal according to the LDI efficient frontier, and test its performance against this range of forward-looking scenarios.

Forecast Yields and Fed Funds Rate

chart_10year_US_treasury_yields_721x320
Data presented is for informational purposes only and is not intended to provide any assurance or promise of actual results. Analysis results are highly dependent on our assumptions and actual results may vary significantly because future market characteristics may not match our assumptions. All market forecasts are subject to a wide margin of error, including our own. Analysis performed using economic modeling, historical comparisons and subjective judgments. Hypothetical economic forecasts were developed using an economic model, historical data and judgment. Economic scenarios: These were specified individually in detail using a global macroeconomic model, the NiGEM model developed at the U.K. National Institute of Economic and Social Research. The NiGEM model was then used to generate five-year forecasts of various economic variables such as growth and inflation, short-and long-term interest rates, corporate earnings growth and lending spreads, and exchange rates.
Source: Capital Group.


To read the entire white paper, “LDI and the Rising Rates Riddle,” download the PDF document.

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Read more about liability-driven investing (LDI) in a rising rate environment.

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Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation. 

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