The Changing Nature of LDI | Chief Investment Officer

(December 12, 2013) — Liability-driven investing (LDI) continues to be a popular strategy among pension plans, but its goals and implementation are becoming more varied, according to SEI.

The seventh annual poll surveyed 130 corporate pensions in the US, Canada, and the UK, and found more than half (57%) of the participants said they currently use an LDI strategy in their portfolio—a slight dip from a record of high 63% in 2011—and more than two-thirds of respondents reported to have used or plan to use a glide path strategy.

“It involves setting acceptable levels of risk within portfolios and establishing key trigger points to shed risk, or de-risk, as the plan funded status improves,” the report said.

aiCIO’s 2013 Liability-Driven Investing Survey reported similar findings—more than half of 119 surveyed investors said glide path was written into their IPS as a ‘contract’ or an ‘intent’ with triggers largely based on funded ratio.

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The pairing is a natural evolution of LDI strategies, according to SEI, particularly as investors’ primary goals for LDI have changed since the poll’s inception.

SEI said although plan sponsors have consistently put “control funded status volatility” first in LDI goals, they expressed more importance of “improving funding levels” and “progress toward termination” in key targets.

More than half of the respondents also said progress in funded status was their top benchmark for pension strategy success. In previous years, sponsors had depended on absolute return of portfolio.

Such change could be attributed to the improving global economy, which has allowed investors better returns, more flexibility, and even an option to re-risk.

“It’s critical that plan sponsors continue to assess current market conditions when considering asset allocation decisions,” the report said. “As markets move, the current glide path or allocation strategy may not meet the plan’s current hurdle rate, and require either additional contributions or longer periods of outperformance to catch up.”

Among US pension portfolios, SEI reported a significant decrease in allocations to US equities this year despite strong performance in the asset class. Instead, 35% of investors have increased their allocations to fixed income despite tapering talks.

In September, UBS had predicted a significant flow of US defined benefit pension capital from equities into bonds—anywhere between $35 billion and $41 billion in equity sales paired with fixed income buys of $19 billion to $22 billion.

The poll also found 67% of surveyed plan sponsors have already closed their plans and 59% have either implemented or are planning to implement lump-sum payments as additional de-risking strategies.

From aiCIO Europe's December issue: Kenneth’s investment book is expanding—and he wants to bring lessons gleaned from being on the sell side to the Pension Protection Fund (PPF).

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There are two reasons why I wanted to come here: one, to practice what I preach, and two, because of the challenge of this particular fund. To secure the benefits of several hundred thousand people… if you manage to do that the right way, it should be a good moral tick in the box. And I’ve been looking at trying to use my skill set in a different way.

Asset allocation always evolves, and we should always look to test our asset allocation theory. For instance, if you’re looking at corporate index-linked bonds, you would normally have it sitting in either the matching bucket or the growth bucket, but it has both characteristics. The way we think about investments now, we’d probably decide on the growth bucket. But doing that, we miss out on the hedging characteristics. I’m not saying that’s something we want to invest in, but there are other assets like it where the characteristics are the same—infrastructure, some real estate debt, things which may help us.

We’ll be creating more flexible mandates for our asset managers than we’ve had in the past. At the moment we have very defined mandates—a credit mandate or a bond mandate. What we’re looking to create is a mandate for extracting assets that may have liability-matching and return-seeking characteristics.

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There will be some evolution here. We’re testing how we invest money. A more holistic strategy will mean we can look at all the different characteristics of certain assets, rather than pigeonhole them in certain buckets. When you start doing that you become inefficient.

We’re a fund with a long cash flow over the next 70 to 80 years, and there’s no requirement to have a portfolio in purely liquid investments. It’s prudent to have a portfolio with some illiquid investments, as long as the premium we can attract for that makes it worthwhile to look at.

Lots of people are talking about illiquidity at the moment but aren’t able to act upon it. There is an issue of how you frame it. We’re doing some project work on that now. We’re trying to come up with one that fits the PPF—because there is no one-size-fits-all version.

Given the size we’re expecting to be in the future, we have to consider bringing certain asset classes in-house. It’s prudent to look to try and be as efficient as possible. If that means bringing assets in-house, then we’ll look at it.

If you look at the liability side of the balance sheet, which is derivatives and government bonds, it’s not rocket science to suggest that if we were to bring any assets in-house, they would be the obvious ones to think about.

I come from a background which is different culturally from the one that I’ve joined. With the banking sector, everything’s a bit of a blur to meet the short-term targets. With the PPF, the most important thing is to set up a strategy process and get the team focussed on how we deliver for the medium and long term.

One of the big objectives is ensuring the PPF is at the forefront of the industry, and to do that we need to leverage a lot more from our providers. Pension funds find it difficult to interface with banks as they’re sceptical about what banks can deliver. They think they’re trying to make a quick buck. I suppose I know all the tricks, if anyone tried to pull one. But I also know how to leverage banks to get the best from them. That’s an opportunity to interact with other providers that we haven’t done in the past.

Banks are aware of innovation in the industry because they have to be at that forefront. If we can ensure that we’re at the forefront of interacting with the banks, we’ll get first dibs on the interesting transactions.