Let’s talk fixed income in Liability-Driven Investing (LDI), but let’s cut through the noise and get to what really matters: U.S. Treasuries. Not corporate bonds, not some complex derivative product, but the simple, boring, rock-solid U.S. Treasury and its inflation-protected cousin, TIPS (Treasury Inflation-Protected Securities). These bonds are the heart and soul of LDI, whether you’re managing a multi-billion dollar pension fund or advising a household on how to meet their future expenses without losing sleep over market gyrations.
Why U.S. Treasuries?
Treasuries are like the kid in class who always shows up, does their homework, and never causes drama. You know exactly what you’re getting. And in a world full of uncertainty, that’s invaluable. These bonds are backed by the full faith and credit of the U.S. government, which basically means they’re the closest thing to risk-free you can get. No credit risk, no hand-wringing over whether the issuer can pay you back. In LDI, we need certainty because we’re not just chasing returns—we’re trying to meet obligations. For that, Treasuries are king.
Why not corporate bonds, you ask? Sure, they offer a little extra yield, but they also carry credit risk. David Swensen, the brain behind Yale’s Endowment success, famously shunned corporate bonds. His reasoning was clear: why take on credit risk when U.S. Treasuries do the job? Treasuries offer the safety and liquidity to get in and out quickly, with no concern about defaults or messy restructuring. Corporate bonds might make sense if you’re hunting for yield, but if your job is to match liabilities and not blow up the portfolio when things go south, you stick to Treasuries.
Short-Duration Treasuries: A Household’s Best Defense
Now, let’s take this down to the level of a working household. What do short-duration Treasuries do for you? They’re a buffer against the uncertainties that keep you up at night—job loss, medical expenses, market volatility, the whole nine yards. Short-duration Treasuries are less sensitive to interest rate changes, meaning they don’t swing wildly in value when rates move. That’s stability when you need it most.
But here’s where things get interesting. When the economy takes a dive or financial markets get rattled, the Federal Reserve typically steps in and cuts interest rates. When that happens, the value of short-duration Treasuries actually increases. So, not only are these bonds safe, they also serve as a hedge in times of economic stress. It’s like having an insurance policy that pays out right when you need it most.
TIPS and the Retirement Lifestyle Floor: A Different Kind of Safety Net
For retired households, the game changes. Now, we’re not talking about buffering against unexpected job loss or paying for your kid’s college. We’re talking about making sure you can cover your essential expenses—housing, healthcare, food—for the rest of your life. Here’s where TIPS come into play.
Michael Zwecher, the guy who wrote the book (literally) on retirement income planning, emphasizes the idea of creating a lifestyle floor. Think of it as your financial safety net, but with inflation protection built in. TIPS are government bonds that adjust for inflation, ensuring your real purchasing power doesn’t erode over time. By matching your essential expenses with these bonds, you’re building a reliable income stream that grows with inflation, so no matter what happens in the economy, you can afford the basics.
Bringing It All Together
Fixed income in LDI isn’t about chasing the highest returns. It’s about matching your liabilities, period. For working households, short-duration Treasuries offer safety, liquidity, and a built-in hedge against economic downturns. For retirees, TIPS provide inflation-protected income that guarantees a lifestyle floor, so you don’t have to worry about outliving your money.
David Swensen knew this, and so do we. The goal isn’t to maximize yield—it’s to make sure the obligations are met. Treasuries and TIPS do that better than anything else out there. So, while they may not be exciting, they’re exactly what you need when safety, reliability, and certainty matter most.
John Grubbs, CAIA®, AAMS®
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