Bonds have outperformed and stocks underperformed to a massive degree this month, so pension funds are going to have to buy stocks and sell bonds to rebalance themselves. I’m no expert on these institutional flows, was wondering whether you guys think this could provide some short term relief to the market this week as these flows come into an illiquid market?
i work for a large investment consulting firm and that’s what the principals/consultants here are recommending to their clients. it usually takes at least 1-2 quarters before they’ll start any implementation. but yeah, expect that trend sooner, as it will definitely provide some support to the equity markets; however, don’t bet on any massive rally simply because of this. there needs to be other fundamentals/policy/market sentiments to backup the rally.
The other angle here is that recently most plans have been advised to reduce equity allocation and align asset and laibility duration. This advice was rendered before the poop had hit the fan. many plans may decide to keep the equity/bond mix thats been reached in this market.
If plans are using a liability-based-investing approach and are fully hedge to the duration of their liabilities then there will be no need rebalance. But rebalancing depends on a whole host of factors including their funding-status and the assumptions of their liability growth, expected returns of asset classes, variation of returns, liquidity issues, protential alpha, etc. Also don’t forget most plans use external managers for equity management so if equity managers get a bucket full of money and don’t see any opportunites they just might leave it all in cash.
No way our equity managers are not allowed to hold cash. They have to be fully invested or give the money back to us so we can put it in an index tracker. Our equity exposure is not held in cash - ever.
I guess it depends on the mandates and if its a commingled/seperately managed account. I’ve seen some seperately managed account manager hold 5% in cash and even higher at quarter-end when they’re rebalancing (but thats was just a timing issue).
"If plans are using a liability-based-investing approach and are fully hedge to the duration of their liabilities then there will be no need rebalance. " There is no such thing as being fully-hedged in this market. Simply impossible. Anybody that was duration matched beginning of September or October now find their Asset duration to be much much lower than that of their liabilities.
cfa-grem, care to walk me through a typical example?
If I have 100% of my liability hedged then my funded ratio may not stay at 100% if assets decline due to market movements. Especially so if my LDI portfolio has equity-like instruments in it. however, my initial liability dollar amount that I hedged will stay hedged. Just duration matching will be ineffective in general because convexity and higher terms plays a role as well. Lets say that I fully immunize by key-rate durations and invest 100% in bonds. In this case I will not have to rebalance. However I will need to cash flow match to pay out benefits.