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‘Convexity’ key as Dutch schemes buy long bonds

NETHERLANDS – Convexity, or the sensitivity of bonds to interest rates, is an important factor as Dutch pension schemes move into longer dated bonds amid the new FTK regulations – according to a market analysis firm.

“Holding high-convexity bonds makes it easier to match assets and liabilities at any given time,” said 4Cast in a note following news that the Dutch treasury was considering issuing 30-year bonds.

Convexity is a mathematical term which measures the sensitivity of bonds to interest rates.

Under the new FTK, the Financieel Toetsingskader or financial assessment framework, Dutch schemes will have to value their liabilities at current market rates.

The need to match assets and liabilities demands an increase in the duration of assets, the analysts said – pointing out that the average duration of Dutch pension fund liabilities exceeds current fixed income investments by around 10 years. “Hence the demand for longer dated instruments.”

Long-dated bonds have higher sensitivity to interest rates than short-dated issues, it added.

“This means that relative to short-dated bonds, price gains are higher in an environment of falling yields and price falls are lower when yields go higher,”

Elsewhere, Merrill Lynch said in a research note today that pension funds are buying long duration bonds in response to tougher liability proposals in the US.

The 4Cast report is available via www.inderec.com

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