Words From the Wise
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Vasan: What are the biggest misperceptions about LDI?
Yawitz: The biggest misconception in my mind is the definition of LDI investing. All investment strategies for pension funds are inherently liability driven, as satisfying the liability is the ultimate purpose of assets. It’s just that some investment strategies are more effective versions of LDI than others.
That’s a revelation that plan sponsors have had over the last decade, which explains the popularity of LDI, perhaps independent of interest rates. Even if you’re agnostic about interest rates, you should begin an LDI strategy. The misconception a few years ago was that one needed a strong view that rates would fall. With Brown Shoe and others, my career has transitioned from investors having an asset-only view to having an asset-liability view—at 30,000 feet, that’s the explanation for the development of LDI strategies. Vasan: Why were you willing to take the plunge into LDI when your peers weren’t?
Yawitz: Much of my academic career, as well as my time at Goldman Sachs, involved fixed-income research that was directly applicable to LDI. So early on, between 1985 and 1990, I saw interest from a handful of corporate plans to undertake what would now be called LDI. When NISA was hatched, we had the benefit of understanding how to do it. An additional factor for NISA’s success: even before we had a lot of LDI business at NISA, all of our business was—and still is—in separate accounts. Most of our competitors managed mutual funds and comingled funds and didn’t have that level of customization. Corporate pension funds want customization. Since we have always customized, it wasn’t a leap for us to customize LDI solutions. We have almost 50 different benchmarks. Clients don’t want an off-the-shelf LDI solution.
Vasan: What’s been the biggest change with NISA’s LDI mindset since inception?
Yawitz: At 30,000 feet, it hasn’t changed. Our clients have always sought better ways to customize LDI solutions, which drives continual improvement. The extension of LDI strategies from fixed-income only to fixed-income plus derivatives is a major change in the last 20 years.
Vasan: When do the benefits of doing LDI become too tempting to resist?
Yawitz: The first step with LDI is changing the benchmark to a long-duration portfolio in order to reduce the volatility of funded status. No one would say that’s difficult. The baby steps that can be taken without broad asset allocation questions or using derivatives—they’re compelling and easy. In order to more fully hedge and build out LDI from there, there are two doors open: (1) include more long duration bonds as a percent of the total asset pool, or (2) add an overlay strategy using derivatives. Even taking a baby step, which is easy, is better than doing nothing. In order not to do that baby step and remain out of LDI, one would need a very strong view that interest rates are going up beyond current market expectations.
Vasan: Will the appeal of LDI ever spill over beyond corporate pension plans?
Yawitz: The momentum for corporate pensions has been key regulatory changes— Financial Accounting Standard Number 87 (FAS 87) and the Pension Protection Act (PPA) are what pushed [American] corporates to dabble into LDI. GASB, with respect to public pensions, has been one push, but it’s probably not adequate to see a groundswell. So it may be years, or perhaps decades, before public plans will be interested in LDI.