Credit Spread Disparities between Assets and Liabilities

Recent legislation in the U.S. (the Pension Protection Act) and the first phase of U.S. accounting reform (FAS 158) mandate that liability cash flows be discounted at high quality corporate bond yields. These credit yield requirements are at odds with a true financial economics framework for pension management and also result in liability benchmarks that are not investible for matching asset strategies. In the current environment, plan sponsors that used Treasury or swaps-based Liability Driven Investing (LDI) programs experienced large asset gains while liabilities changed only slightly. This relative gain should reverse slowly over time, but Treasury or swaps-based LDI will remain a key component of most matching strategies.