Research

Pension funds and tax reform: how to deal with a double-edged sword

April 27, 2018
| United States

By Nimisha Srivastava and Brett Vanover

The new tax reform bill could have an enormous impact on pension fund credit portfolios — one we believe has yet to receive the attention it deserves. While market participants have been focused on the benefits of tax reform for major risk assets, very few have taken into account the potential effects to their hedging portfolios, which continue to grow in importance as more of these plans move closer to their end goals.

Specifically, we see three potential consequences of the tax bill:

  • Lower supply of long-duration credit: A reduction in corporate taxes could decrease issuance of corporate credit, in particular, long-duration credit, a key component to pension fund liability management.
  • Supply/Demand imbalance: Heightened demand for long-duration credit from defined benefit plans and nontraditional investors could exacerbate the supply/demand mismatch that already exists.
  • Wider scope of assets needed in liability hedging: We believe pension plans should consider expanding the opportunity set for hedging portfolios to include asset classes outside of long-duration corporate credit. This could include securitized credit, private credit and/or tax-exempt municipal bonds.

We discuss key considerations arising from the new tax code, provide a more detailed overview on the current state of the U.S. credit market and, ultimately, address how pension funds can minimize possible adverse scenarios. Download our white paper to learn more.

Graph showing the supply and demand trend of pension fund, the current supply is not enough 

Source: ICI, Barclays Live