LDI Preferred to Pension Risk Transfers for De-Risking

Research by EDM Group has found investors will choose liability-driven investment strategies over other de-risking approaches.

(October 29, 2013) – Almost a third of pensions investors believe liability driven investment (LDI) will be a “very popular” way to de-risk over the next five years, beating longevity swaps and pension buyouts, according to EDM Group.

The information management firm reported that 30% of pension investors thought LDI would be a very popular way to de-risk, with another 24% saying they believed it would be “quite popular”.

Another 31% believed pension buy-ins would be very or quite popular, and 28% believed buyouts would be the de-risking tool of choice. Another 28% said longevity swaps would be very, or quite popular.

However, almost half of respondents were concerned about their standard of data management within their pension funds, saying the poor quality of data and information management is having a “negative” impact on their ability to de-risk schemes.

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Only 51% believe that over half of final salary pension data/information is currently stored in digital format but 78.3% think this will be the case in five years’ time.

In addition, 45% expect pension schemes to invest a lot of time and money to improve the quality of data/information they collect over the next five years. As many as half of all investors will choose to hand that responsibility to a third-party.

The research questioned a global audience of almost 200 pension professionals, around half of which were from the UK.

The shift towards LDI could reflect concerns about a lack of capacity for the pension risk transfer market. 2013 has been a record year for buyout and buy-in transactions on both sides of the Atlantic, but many experts have warned that in the longer term, there may be problems as insurers become more selective in choosing deals.

“We can expect to reach a point fairly soon when there will be far more pension schemes wanting to buy out than there is capacity in the market to absorb them,” Alastair Meeks, partner at law firm Pinsent Masons, said in August 2013. “Some, perhaps most, of those schemes are going to find their plans thwarted. The successful schemes will be the schemes that are ready to move fast.”

However, David Collinson, co-head of business origination at Pension Insurance Corporation (PIC), disputed claims of capacity constraints.

“We have plenty of capacity,” he told aiCIO. “And if the market expands, we will raise more capital from investors as we have done in the past.”

PIC has led the field in the UK this year with £2.28 billion of buy-ins and buy-outs announced, giving the company a market share of over 70%.

Watch out for the next print edition of aiCIO, which focuses on the present and future of the LDI market.

Home > News > Risk > The Extreme Risks Threatening Investment Portfolios

Risk October 29, 2013

The Extreme Risks Threatening Investment Portfolios

Forget the banking crisis, the most pressing extreme risks threatening investments are much more terrifying.

(October 29, 2013) –The global financial meltdown should be considered yesterday’s news, as investors have new concerns keeping them awake at night, according to consultant Towers Watson.

In its annual assessment of extreme risks, Towers Watson said a crisis in the provision of food, water, and energy was the top of the three risks most likely to occur. Second in the group was economic stagnation, with a global temperature change being placed third.

This troika of events would have severe impacts both around the world and in the local areas in which they happened, Towers Watson said.

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To help investors through the risk minefield, the consultant made suggestions about which assets to select to either avoid or take advantage of potential catastrophes.

These included securities providing exposure to resource in shortages or beneficiaries of substitution, globally-diversified long-dated sovereign nominal bonds, and land “in the ‘right’ place”.

Many large pension funds and other institutional investors have already begun buying up a diverse range of energy-producing firms and plants.

Last year’s winners of this extreme risks–which were mainly related to financial collapse–have fallen down the likelihood scale. The survey showed either a banking crisis or sovereign default was less likely than the three risks above.

In fact, sovereign default has the same risk profile as that of nuclear contamination. Interestingly, extreme longevity shocks were cited as a one in 100-year event.

Investors should take heart though. Towers Watson said the events that could cause the most damage to the widest population were also the least likely to occur, but investors should never discount the possibility of the infamous black swans.

“The power of the ranking system is that it combines and trades-off the four risk scores in a consistent manner,” the report said. “Different weights could be applied, but the importance of a ranking system is to challenge pre-conceptions (and mitigate black swan biases). Whatever the weights, the ranking highlights the risks to prioritise when it comes to management actions.”

End note: Towers Watson helpfully added to the report that risks scoring very highly in each section were discounted. The consultants said: “This is a result of the filtering process applied that excluded the bottom 15 extreme risks which we believe require less attention for the purpose of this paper. For example, we believe that an alien invasion is a potentially existential risk, with high uncertainty, very unlikely (one in every 100+ years) and with impacts affecting all future generations (pan-generational).”

To read the full list of extreme risks, and a study on the methodology, click here.

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