As we move beyond discussing market volatility and outlooks, we will identify opportunities defined benefit (DB) plan sponsors can take to move forward. A key opportunity for qualified DB plan sponsors is to use a hedge path to reduce the duration of fixed income while interest rates are low.
What is a Hedge Path?
Hedge paths are a systematic way to manage the duration exposure of the liability-hedging portfolio based on interest rate levels.
- As interest rates remain low, hedge paths would move the duration exposure of the liability-hedging portfolio lower.
- As interest rates increase, you would buy into longer duration instruments as those yields become more attractive.
What is a Glide Path?
It’s important to note that, while they use similar terms, hedge paths and glide paths are different. A glide path is a de-risking policy where the asset allocation shifts from return-seeking assets to liability-hedging assets as the funded status increases. That is, when the funded ratio increases, the plan adds more fixed income.
Glide paths and hedge paths can work together or independently. You could adopt a glide path without a hedge path or a hedge path without a glide path.
Benefits of a Hedge Path
Hedge paths can improve the risk/return prospects for pension plans. As Treasury yields today are near historical lows, hedge paths reduce duration now, which makes the range of possible returns for long-duration bonds is unattractive. When yields are so low, there is a broader range of possible bad returns than good ones. In addition to reducing duration now, hedge paths also put a plan to extend duration as rates rise.
To learn about the other investment opportunities and special considerations for DB plan sponsors, watch our webinar replay Investment Implications for Qualified Defined Benefit Plans.
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