Pension Plans Betting on Interest Rates

Bob Collie, chief research strategist, Americas Institutional, Russell Investments, recently spoke with PLANSPONSOR about pension plans and interest rates. “Over the last few years, and the last four years in particular, interest rates have been causing problems for defined benefit (DB) plan sponsors. Many people feel things have turned a corner more recently and that rising interest rates are good news for pension plans. That is true in one sense. It means that liabilities should fall and pension investments should improve.”

However, he cautioned, there are two things DB plan sponsors need to consider for investments related to interest rates. “One is the scale of the bets on interest rates. The other is how much interest rates need to rise before it pays off for investors.”

Collie added, “Just because interest rates go up, it doesn’t tell you whether it’s a smart bet. Interest rates have to rise a certain amount before it pays off for investors.”

Some DB plan sponsors are holding off on pursuing a liability driven investment (LDI) strategy, waiting for interest rates to rise. But, Collie said “an LDI strategy is the way to go, regardless of the interest rate environment. It’s not just the price of the bet that investors are making, but what interest rates do relative to what others think they’re going to do.”

Collie examined the connection between pension plans and interest rates more closely in a recent article for Russell, which touched upon the question of whether interest rates will rise enough to provide relief for DB plan sponsors.

“Interest rates could conceivably go up quite a bit, but I am looking at what’s most probable to happen. Plan sponsors need to remember that when the market expects something to happen, the pricing of that investment usually reflects that.”

In the article, Collie concluded it is not enough for interest rates to rise, but a break-even point needs to be overcome before a gain occurs. Based on historical data, he said, investors need to understand rising interest rates do not necessarily equal “easy gains.”

Collie’s article can be found here.