Treasury Replacement

5 Important Questions to ask about your Treasury portfolio

As part of our series, reviewing the top content from asset managers on how to adjust portfolios given the low yield...

January 8, 2021

As part of our series, reviewing the top content from asset managers on how to adjust portfolios given the low yield on bonds, here are our top 5 questions that public pension plans should be asking with regards to their Treasury portfolio.

1. What are the main roles that Treasuries play in the portfolio?

The starting point is getting clear on the outcome that the pension plan is hoping to achieve by maintaining an allocation to Treasuries. Is it primarily a reserve portfolio for liquidity needs, or is it as a diversifier / risk mitigating asset?

2. Are treasuries still the most effective asset for those roles?

The current low level of yields may impair the ability of Treasuries to fulfill the outcomes the plan is hoping to achieve by the allocation. Or at least, the trade-off between Treasuries and other alternatives may have now changed.

3. Is the pension plan comfortable deploying a prudent amount of leverage?

This is a key constraint on the opportunity set available for replacing or complementing the Treasury allocation. In particular, the opportunity cost of Treasuries is significantly lower if they are maintained using Treasury futures, rather than a physical allocation.

4. Would the use of better risk-mitigating assets enable the plan to hold more growth assets and less Treasuries?

It is always important to consider the broader portfolio impact of any changes to the Treasury portfolio. If more effective risk-mitigating assets are deployed, then the overall plan risk is lower. If the main objective is not to reduce risk, then some of the risk reduction can be recycled back into a higher allocation to growth assets and thus higher expected returns.

5. How exposed is the portfolio to rising inflation? 

The wildcard question when considering the impact of low bond yields is how exposed the portfolio is to inflation. The Bridgewater research does a great job explaining the trade-offs. Both stocks and bonds do well in deflationary environments and less well in inflationary environments. However, the benefit of holding bonds alongside stocks is due to the different performance in economic downturns. With that benefit diminished due to lower starting yields, the diversifying benefit of protecting against inflation could be more beneficial for future environments.


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Ed Studd

CEO, Zermelo

Ed is passionate about helping institutional investors meet their goals through better custom solutions. Prior to Zermelo, he gained extensive experience across asset management, investment banking and investment consulting.

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