Case Study in Liability-Driven Investing

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.