Commercial Mortgages: An Alternative to Long Corporate Bonds for Pension Plan De-Risking

Abstract

High-quality, long-duration commercial mortgage-backed securities (CMBS) are worth consideration by corporate defined-benefit pension plans that are shifting asset allocations from equities to fixed income for de-risking. The author’s research suggests that high-quality, long-duration CMBS can be a viable alternative to long corporate bonds in a plan’s fixed-income allocation, given the sector’s growing market size, more stable and predictable cash flows, reasonably high correlation to long-duration corporate bonds, and relatively low default risk. An allocation to AAA-rated long CMBS can also diversify and mitigate the issuer concentration risk inherent in allocations to high-quality, long-duration corporate bonds, particularly for larger plans. For plans with allocation to equities, adding high-quality CMBS can reduce funded-ratio risk at the plan level, because these securities are less correlated than corporate bonds to equities.