I Don’t Always Invest Pension Assets, But When I Do, I Prefer Duration Matching

To see this article in digital magazine format, click here. 

“I get that construct,” says the most interesting ex-pension manager in the world, Jay Vivian, referring to the cover of this magazine. “I mean, you’re not even old enough to remember that Time cover, and LDI isn’t dead—but it’s certainly changed.”

Vivian should know. As head of the IBM pension fund group from late 1999 until his fortuitous retirement a week before the market peaked in October 2007, he was one of the pioneers of putting liability-driven investing into practice. Since his retirement, he has stayed active in the pension community via old friends, a few non-profit boards, and CIEBA, the group’s industry body.

“One big change is just in general markets,” he opines. “It used to be viewed as a safe bet that stocks would outperform bonds over the long run. ‘But is that still true?’ people are asking. What once was somewhat novel [giving up stocks for bonds] is now, perhaps, more palatable. Long bonds not only help you hedge against liabilities, but they supposedly have less downside risk than stocks.”

Another difference, Vivian thinks, is the changing perception of derivative use in LDI strategies. “People may be less comfortable with derivatives now [compared to pre-crisis]. Five years ago, there weren’t a lot of plans using swaps, because they are complicated—but they weren’t viewed as very risky. Now, they’re still complicated, and they’re viewed as risky.” It’s a structural problem, Vivian believes, in part because of what happened in the collateral and liquidity worlds. “Going forward, collateral is moving toward centralization, and there are issues with reporting and fiduciary handling. If a fund uses LDI derivatives that require collateral (and many do require it), it could be a big operational headache and a big liquidity challenge.”

“There’s one other thing I see changing,” he continues. “Some—many?—are discussing ‘glide paths’ for hedging as a function of fundedness and/or rates. For example, one fund has pre-approved shifting from stocks to long bonds in 10% increments as fundedness improves in 5% increments.” That’s LDI implementation, he says, “though it doesn’t show up in current asset weights and uses long bond physicals, rather than derivatives. I’ve heard of similar programs that will increase the liability hedge ratio by 15% for every 1% increase in long rates over 3%.”

But onto less serious topics —Vivian isn’t the most interesting ex-pension manager in the world for nothing—“I have an idea for a humorous twist on your God is Dead theme,” he emailed a few days after speaking with me.

“See if you can work in the two fantastic Monty Python skits about deadness. (1) ‘The Dead Parrot’ skit: Pet store owner tries to convince [a] disgruntled buyer that a Norwegian Blue parrot is resting or pining for the fjords although the only reason it’s still upright is because it’s nailed to its perch. (2) Monty Python and the Holy Grail ‘Bring Out Yer Dead’ skit: A body being thrown on cart of those killed by plague sits up and says ‘I feel fine’ and ‘I think I’ll go for a walk.’ The question is, which one better describes LDI’s ‘death’?” 

Click here to see the full feature article.

—KPM