What to Ask of Your LDI Manager

It’s not just “set and forget” with LDI – regular updates are needed, consultants warn investors.

(November 7, 2012) — Pension funds are not keeping a watchful eye on their liability-driven investment (LDI) managers and could suffer as a result, a consulting firm has warned.

“Many pension funds see their LDI managers put swaps or gilts in place to hedge out risk and then walk away,” said Pete Drewienkiewicz, head of manager research at UK-based investment consultant Redington. “CIOs and trustees cannot just ‘set and forget’.”

Drewienkiewicz said putting triggers into place for an LDI strategy did not mean investors could walk away from the portfolio thinking the job was done.

“Trigger rates are useful, but they should not mean all responsibility is delegated. Many pension funds do not consider what would happen if these triggers are not hit and derisking does not happen in the time frame they thought.”

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CIOs and trustees should be more demanding of their LDI managers, Drewienkiewicz said, and encourage them to take a more opportunistic approach to managing their portfolio.

“There are assets, such as long-term leases and social housing, which need less collateral than swaps, for example, and several buyout managers are already using them, making them a good match should a pension fund be moving in that direction. Some of these are also desirable for pension funds under a Solvency II framework, should that be implemented in its proposed form,” Drewienkiewicz said.

Redington also urges its clients to demand better reporting from their LDI manager when setting up their initial contract, Drewienkiewicz said, to ensure the strategy was appropriate for the fund’s overall framework.

“Investors have to understand what risks an LDI manager is taking. Just because they are running a passive mandate, it does not mean it is low risk,” said Drewienkiewicz. “Pension funds have to be sure of their risk limits – not to prevent their manager taking risk necessarily, but to understand what is going on throughout their entire portfolio.”

For an in-depth examination of LDI and its evolution, see aiCIO‘s dedicated edition released later this month.

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