Episode 63

AUGUST 17, 2022

Annette on long duration fixed income

Annette Serrao, Managing Director, Fixed Income Portfolio Manager at SLC Management, discusses her team's approach to investing in long duration assets on behalf of clients.

Steve Peacher: Hi, everybody! It's Steve Peacher, head of SLC Management. Thanks for dialing into this session of “Three in Five.” And today I’m with Annette Serrao, who is a managing director and fixed income portfolio manager for SLC. Annette, thanks for taking a few moments today.

Annette Serrao: Hi Steve, Thanks for having me.

Steve Peacher: So we want to talk about an area that you spend a lot of time on, which is the long duration, the long credit part of the market. Let's start by just talking about that segment. What makes it so unique? And how do you go about implementing long credit strategies in client portfolio?

Annette Serrao: Sure thing. Insurance companies in the U.S. and overseas, along with pension funds, have been a major source of demand for long duration assets. Long credit plays an important role due to the need for duration to hedge these long-term liabilities or yield targets in some cases, that is major life insurance companies after adjusting for, of course, the hedging costs. So our clients in the long duration strategies, either through LDI or benchmark to the Bloomberg Barclays Long Credit Index, are primarily proper DB plans. So in terms of portfolio implementation in the long end, we value capital preservation over chasing yield versus the benchmark. So this means moving the portfolio up in quality or adding treasuries versus credit at tighter spreads. Issue selection has been a main driver for excess returns, and as these strategies are duration neutral versus the benchmark, so we are constantly looking at relative values in the long end at an issuer level by looking at historic relationships versus similar names compared to bonds within that sub sector or names with similar leverage profiles and ratings. In our LDI portfolios we tend to cap BBB names inside of ten years, and generally hold high quality long and corporate payments in the longer part of the curve, as one of the goals of the LDI strategy is to keep up with benchmark liabilities and reduce funding more.

Steve Peacher: You know, market segments in all markets are kind of always evolving and always changing. So, if you think about the long end of the market, how has this changed over the last two years kind of going for pre-covid, to covid, to now?

Annette Serrao: I’ll cover three different themes in that. One is in terms of index characteristics. So, the composition of the Long Credit Index has changed over the past ten years. So leveraging transactions, change of capital allocation policies by corporate issuers, has led to an increase in the weight of the BBB portion of the index, and that is mainly skewed by industrial issuance. The second thing is the U.S. Treasury reintroduced the twenty-year treasury in 2020. And since then it's been maybe a year from there that corporate bonds around the majority around twenty years started to trade versus the 20-year Treasury versus the previous market convention of the 30-year Treasury benchmark. So this change up boosted liquidity in the twenty-year part of the curve and since then has also led to a pickup in corporate issuance in the twenty-year charge. So this twenty year also comes tends to come under pressure when vol picks up due to its supply demand dynamics, and this has led to the inversion of the 20s, 30s Treasury Curve since October last year. And it's currently trading around 23 basis points inverted.[1] So what this means for long credit portfolios, you've seen flat, inverted, curves in some cases in the corporate curves, and this is me at the twenty-year corporate paper look attractive in an all-in year basis. And the third topic I’d like to cover in this is issuance. So 2020 and 2021 had a higher percent of issuance in the long end, so long end as in ten plus years relative to its five-year averages. The lower rates, access to markets due to fed policies, help these companies extend majorities to boost liquidity around near to maturities and refinance high coupon debt. So this year has been a little different story with higher rates and financial issuance dominating year to date numbers, supply has been lower in the longer end.

Steve Peacher: You know you mentioned pension funds, which is one of the types of clients that you manage money for, and with the markets down I think a lot of people don't realize that with rates up it has actually been a good thing for many pension funds in terms of their funded status. So Funded Status Act, even though the asset side of a pension, one may have gone down their funded status, the relationship between the assets and the liabilities, have actually improved. So funded status for many pension funds is up, you know a lot of pension funds manage their funds on a LDI basis, or liability-driven basis, where they're trying to really match assets to liabilities. So as you look at markets, as you look at the improvement funded status, what should all the I clients focus on in this environment?

Annette Serrao: So higher rates in 2022 have gotten most of these pension plans either fully funded, and in some cases even overfunded. I think it was the Millman Pension Fund index that pointed out that the last time plans were fully funded were in 2007, and our Client Solution Group also publishes a pension monitor every quarter, so which is also interesting, and the thing that got my I was in the fifteen years since then for these pension plans to get back to full funding. So, basing on this experience and also the market pricing in rate cuts in 2023 due to recession risk, I think pension funds should take advantage of the current status and de-risk pension plans. This could be achieved by a combination of either increased allocation to bonds, but based on their LDI glide path. Diversification either within fixed income or maximizing hedge ratios by using long duration credit.

Steve Peacher: You know the long end of the credit market can be a fast-moving market because the durations are long, so as interest rates move that part of the market was around.  You're also fast moving, because I know you got a one-year-old that probably takes some a lot of fast movements track of. So, talk to me about your one-year-old, and what's going on, and how things are changing now that they hit that one-year mark.

Annette Serrao: Oh, my things are changing quite fast. She's just started to walk and she's saying a few words. She's saying ‘dada’ but not mama. So that is a work in progress, and that's how she's keeping me active physically. I need to baby proof the house because I thought it'd be maybe a couple more months before she starts walking. So now it's just running behind her and seeing that she doesn't break things and drop things around.

Steve Peacher: Well, I've forgotten those days, but I my first grandchild's due a week, so it's good to, I mean I now have to remember all these things that we're going to have to start thinking about as grandparents. You mentioned a child proofing a house. Oh, my Gosh! I haven’t deal with that for twenty-seven years. Well, Annette, thank you very much for taking the time, and thanks everybody for listening to this episode of “Three in Five.”

Annette Serrao: Thank you.


[1] Bloomberg 2022


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