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Friday, March 29, 2024

Guest Post: Liability-Driven Investing & Equity Duration: Implications and Considerations for Investors

Courtesy of Tyler Durden

Submited by Yves Lamoureux of Macquarie Private Wealth

Liability-Driven Investing & Equity Duration: Implications and Considerations for Investors

Asset classes behave as expected – at least for some of us. Scenarios of both deflation and hyperinflation appear priced in. Do not expect to get rewarded on confirming events.

Our recent performance underscores the benefit of thinking in terms of liability-driven investing.

http://www.zerohedge.com/article/guest-post-strip-g-rated



Analyzing pension liability risks is the first step in determining future market influences and direction. A major error of judgment by portfolio managers at the end of the 90’s was allowing equities to continue to dictate asset allocation. The equity premium has not materialized in the last 10 years.

You know where we stand: bonds will outperform stocks.

http://www.zerohedge.com/article/yves-lamoureux-observations-negative-risk-premium-and-return-assumptions



The massive exodus of retail investors from stocks will eventually end. I am ready to suggest buying any cheap stocks the market offers but I am not holding my breath.

We have already suggested looking at grains and soft commodities on top of long treasuries to be adequately immunized. I did by the way recently warn that it was too crowded a place. With the recent correction in Treasuries, it does give us a further entry point and, yes I am still in the bull camp.

http://www.businessinsider.com/the-bond-trade-looks-crowded-but-keep-buying-the-dips-2010-8



I have also been a strong hard asset follower for quite some time. I am now worried that this trade has become too crowded. Let me explain.

Let’s take, for example, an inflatable life raft. If maximum capacity is 12 people and 36 poor souls looking for escape and survival climb aboard, the life raft will sink and will defeat its purpose. This is perhaps the tragedy in the making now in gold and corporate bonds.  High uncertainty surrounding markets supports behaviour pricing big risk premiums in anticipation of events.



One key catalyst for hyperinflation that is not found is wage pressures, as wages must be forced up. You also do not find a loss of productive capacity but rather you find more capacity underutilized.  I certainly can tell you that you do not see hot money moving in and out of the USA as it only wants to get out.

In studying behaviour we have this huge lacuna where complacency is the order of the day. Really? When was the last time you heard news of a run on a bank ? It is one of the traits of lost of confidence in a system. This is one that has always amazed me. If you knew your bank was going under, wouldn’t you rush to get as much out as you could? In this case, it would seem not. This is an essential trademark of hyperinflation to sustain itself. If not, it only flares up and is over quickly.



I am always delighted to show the equity duration graph. Here is the most recent version courtesy of Aye Soe at Standard and Poor’s. You will notice that equity duration has become shorter and stands at 21 years. It is important for pension funds to understand this concept as a way to match their assets with their longer duration liabilities. In practice, this will drive most pension funds toward long duration bonds and longevity products.

Using an empirical approach, they estimate the duration to be 9.63 years as of mid-2010. You will notice the difficulty in matching liabilities with shorter duration equities. A point I have always referred to as a mismatch.



Here is a novel strategic idea for regular folks in these uncertain times:  CASH



Yves Lamoureux



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The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Macquarie Private Wealth Inc. (MPW). Every effort has been made to ensure that the contents of this document have been compiled or derived from sources believed to be reliable and contains information and opinions which are accurate and complete.  However, neither the author nor MPW makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Past performance may not be repeated.  Information may be available to MPW which is not reflected herein.  This report is not to be construed as an offer to sell or a solicitation for or an offer to buy any securities.

No entity within the Macquarie Group of Companies is registered as a bank or an authorized foreign bank in Canada under the Bank Act, S.C. 1991, c. 46 and no entity within the Macquarie Group of Companies is regulated in Canada as a financial institution, bank holding company or an insurance holding company. Macquarie Bank Limited ABN 46 008 583 542 (MBL) is a company incorporated in Australia and authorized under the Banking Act 1959 (Australia) to conduct banking business in Australia. MBL is not authorized to conduct business in Canada. No entity within the Macquarie Group of Companies other than MBL is an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Australia), and their obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any other Macquarie Group company. Macquarie Private Wealth Inc. is a member of the Canadian Investor Protection Fund and IIROC.





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