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US pension plans increase allotment to long corporate bonds

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US corporate pension plans appear to be increasing their allotment to long-term investment grade corporate bonds to protect themselves against the looming threat of soaring liabilities,

US corporate pension plans appear to be increasing their allotment to long-term investment grade corporate bonds to protect themselves against the looming threat of soaring liabilities, according to Standish Mellon Asset Management.

Since the beginning of 2009, pension plans have added more than USD1bn for Standish to invest in these bonds.

Standish expects the yields on long-term investment-grade corporate bonds to fall back to more typical levels, which will push up pension plan liabilities substantially. The value of plan liabilities moves inversely with long-term investment-grade corporate bond yields.

"We are in a rough patch for pension plans," says Kent J. Wosepka (pictured), chief investment officer of active fixed income for Standish. "However, this period has some major differences from previous episodes of market volatility. For example, during the 2001 recession, equity prices fell, which decreased the value of pension plan assets. At the same time their liabilities rose due to movements in the bond markets."

This time around pension plans have suffered from a 40 per cent plunge in equity markets. However, Wosepka says the significant increase in corporate bond yields actually reduced the current value of plan liabilities, helping to mitigate the pain to overall plan funding levels. The risk for pension plans is that corporate bond yields could fall back toward more normal levels, which could send liabilities soaring. If equity markets do not continue their rally, pensions could face severe funding issues, he says.

"One way to cushion the impact of falling yields would be to invest plan assets in long-term investment-grade corporate bonds, which is what we are seeing from a number of pension clients," says Andrew Catalan, senior portfolio manager and director of investment grade strategies at Standish. "These bonds move in tandem with plan liabilities. Investing in long-term investment-grade corporate bonds can provide protection against rising liabilities due to a declining discount rate. In addition, the yield on many investment-grade corporate bonds exceeds eight per cent, making them attractive in their own right."

Standish Mellon Asset Management is the fixed income specialist for BNY Mellon Asset Management.

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