Towers Watson Study Shows LDI Gains Traction Among German Companies

(September 20, 2010) — A recent survey by Towers Watson has found that German multinational companies have been using hedging strategies, liability-driven investment (LDI) — which aims to protect funds from market downturns — and increasingly alternatives, while reducing equities.

In the consultancy’s second Pension Risk Management Survey of German multinational companies, Towers Watson studied firms with combined plan assets of €70 billion. The research revealed that the number of companies using inflation hedging – employing long duration or inflation-linked bonds and interest rate swaps – increased from 8% last year to 31% this year, IPE news reported. Additionally, three-quarters of surveyed companies saw their asset allocation of their liabilities as a ‘major risk’ for balance sheets, with 74% adjusting that allocation to better manage volatility.

Towers Watson’s research also showed that while many German pensions have continued to cut their equity exposure, which was down from 22% last year to 16% in 2010, they’ve significantly boosted their exposure to alternatives.

In related news, a strong focus on liability-driven investment has helped the £7.4 billion ($11.4 billion) ICI Pension Fund earn a return of 5.5% a year over during the past decade compared with 3.7% for the average UK defined benefit pension scheme.

The fund — which has 80% of its assets in an LDI portfolio, 10% in equities, and 10% in alternative investments — was one of the frontrunners of LDI, adopting the portfolio approach in 2000 when it hired Barclays Global Investors to implement a hedged strategy to protect its sponsor from big market swings, the Financial Times reported. “You would not expect a low risk portfolio to perform as well over the next 10 years as a higher risk portfolio, but it has done better for us than higher risk investing over the last decade,” Charles Amos, chief executive of Pension Secretariat Services, which runs the ICI Pension Fund, told the FT.

The embrace of LDI, as reflected by recent studies and by the returns of pensions around the world that have adopted the strategy, underscores how pension fund managers have adjusted and improved their risk management techniques to weather the economic crisis.