Bond Demand Influenced by Pensions
There is a lot of evidence, anecdotal and otherwise, that various capital markets are affected by policy. The impact on price and trading volume depends on a host of factors, not the least of which is the nature of the new rules and regulations. So it is with government bonds, domestic and foreign.
In the aftermath of the Pension Protection Act of 2006, many plan sponsors, under pressure to address funding gaps, are adopting an active stance towards interest rate risk management. While strategies can and do vary, trading in bond markets in the U.S. and elsewhere have been affected by a surge in demand for longer-term bonds. According to Reuters journalist Richard Leong, "Appetite for 30-year bonds and other long-dated assets has been fierce as pension fund managers have been stocking up on them to ensure they have enough income-generating assets to meet future obligations, traders and investors said." Additionally, stripped bonds "offer longer duration and more predictable income than a cash bond." (See "Pension demand leads to long bond stripping," December 7, 2006.)
By definition, a stripped bond represents a decoupling of the interest portion from the repayment of principal. The latter is sold as a zero coupon bond. According to Investor Words, "Strip is an acronym for Separate Trading of Registered Interest and Principal of Securities."
Much more will be written about interest rate risk management in later posts. For now, you can find definitions, checklists and step-by-step examples in a book I wrote in 2005 for John Wiley & Sons. Entitled Risk Management for Pensions, Endowments, and Foundations, there is an entire chapter about fundamental concepts. Other chapters address futures, options and swaps, respectively.
Competing methods and products to manage interest rate risk abound. However, the tradeoffs are far from identical. This means that plan sponsors are quickly having to learn about financial risk control, whether they like it or not.
