Meeting Liabilities, Reducing Risk
Objective:
Fund a $100 million liability in 10 years
Current Solution
Investment-Grade (IG) Corporate Debt
- Duration of 8.7 matches liability relatively closely
- Spread duration of 8.5
- Significant exposure to credit spreads widening
- At 2% yield (and a spread of ~1%), risk of spread widening is asymmetric to the downside
Alternatives
Non-Agency Mortgage-Backed Securities (MBS) and Private Credit
- Invest in a blend of US Treasuries, Non-Agency MBS, and potentially private credit
- By targeting increased cash flow yield in Non-Agency MBS and private credit:
- Credit risk is greatly reduced (>70% of assets invested in US Treasuries)
- Spread widening risk (spread duration) in minimized
- Possibility of reinvesting at higher yields in the future is preserved
In order to meet the $100 million liability in 10 years with IG corporates, just under $82 million must be invested today. For comparison, over $90 million would be required using only 10-year US Treasuries. The alternative portfolios take their starting invested size from the IG corporate portfolio, investing in a combination of US Treasuries, Non-Agency MBS, and potentially private credit.
Because yields on Non-Agency MBS and private credit are significantly greater than IG corporates, only a fraction of risk assets are required to meet the liability.
- Utilizing Non-Agency MBS can reduce investment in risky assets by 75%
- Adding private credit, risky assets are reduced by over 80%
By adding 20-25% of low duration, low credit risk Non-Agency MBS you’re able to increase your overall credit quality by allocating the remainder to US Treasuries.
