During the recent period of rising interest rates, the liabilities of Greenfield Pension Fund have become increasingly sensitive to rate changes. As the pension fund manager, your goal is to maintain a stable funding ratio by applying a liability-driven investment strategy, particularly focusing on duration matching.
The current liabilities of the Greenfield Pension Fund are projected to grow by $2 billion over the next ten years, with cash flows of $300 million due in 1 year, $400 million due in 2 years, $500 million due in 3 years, and an increasing cash flow of $200 million each subsequent year until year 10. The fund currently holds a portfolio of bonds with a duration of 7 years and a market value of $3 billion.
Describe a comprehensive approach to duration matching that addresses the specific characteristics of the pension fund’s liabilities. Your response should include the duration of the liabilities, assessment of the interest rate environment, potential strategies to manage duration risk, and any potential challenges or trade-offs involved in implementing your strategy.