Avoid the Agg Drag
- Some defined benefit pension plan sponsors that have not begun to de-risk are hesitant to shift out of Agg-based fixed income allocations toward longer-duration mandates in the current environment, citing the specter of rising interest rates.
- Lengthening the duration of the existing fixed income portfolio can immediately lower surplus risk, without the need to reduce the allocation to growth assets.
- The Agg’s duration and composition mean it isn’t well suited to track a long duration liability that is discounted based on high-quality corporate bonds.
- Even ignoring the liability, a long-duration strategy may actually outperform the Agg if interest rates do not rise by as much as or as fast as is already priced into the yield curve.
We advise extreme caution in using derivatives to protect portfolios from sharp equity drawdowns. We recommend that investors look to asset allocation to defend against equity risk before buying puts. For those investors who must pursue a tail-risk hedge, we provide a list of potential pitfalls and solutions, in the form of a case study.
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