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LDI Pocket guide - Your guide to Liability Driven Investing

  • 15 September 2016 (5 min read)

AXA IM’s Liability Driven Investing Pocket Guide 2016

In our fourth Liability Driven Investing Pocket Guide we aim to bring you insights and views on the LDI market as well as helping to address the most pertinent questions facing the UK’s DB schemes today.

UK defined benefit (DB) pension schemes have made a concerted effort to ‘de-risk’ in the last 10 years, and UK plc has made significant contributions to reduce funding deficits over this period. Alas, these actions have coincided with falling bond yields, and despite broadly positive asset returns, scheme deficits have actually widened.  Against this backdrop, schemes are now maturing and approaching peaks in the amount they need to pay out in benefits. All of this means that going forward, schemes’ assets will need to generate income as well as achieve growth.

Investing to meet benefit payments

As pension schemes explore ways of investing to meet benefit payments, Huw Evans of BESTrustees considers the need for greater focus on the stable, income-generating qualities of a scheme’s assets. 

What does LDI achieve?

More than 1,000 UK defined benefit (DB) schemes currently use LDI strategies, with smaller schemes outnumbering larger schemes in this count. AXA IM’s Tracey Milner re-examines how LDI can help schemes of all sizes to meet the competing objectives of generating income while improving solvency.

Evolution not revolution: how LDI has evolved

LDI pooled funds, through a long-term liability matching approach, can enable pension schemes to better manage their journey towards self-sufficiency or buy-out. LDI pooled funds have evolved significantly over the years, and the range now available provides opportunities for pension schemes to implement an LDI strategy that best meets their needs in a cost effective way.

The magic of behavioural economics

Traditional economic models assume that people are always rational decision makers who fully analyse data and act logically before they reach conscious decisions to maximise outcomes. Behavioural Economics disputes these assumptions: humans often make mental short cuts rather than use logic. Paul Craven, Founder of PCP, explores how to benefit from some of the insights that Behavioural Economics offers.

Why not invest in LDI?

Many UK pension schemes have implemented LDI strategies, however evidence suggests that many schemes have considered LDI but not adopted it. Schemes that decide not to hedge liabilities based on assumptions about levels or direction of interest rates may be missing out. We reveal some commonly overlooked benefits of LDI through an examination of some of the perceived drawbacks.

Investing Like An Insurer

Barnett Waddingham outlines how pension schemes could benefit from insurers’ deep experience of managing the run off of portfolios of annuities. After a defined benefit scheme closes to accrual and achieves full funding, the investment challenges of managing the maturing scheme are similar to those faced by an insurer running an annuity book. This article looks at some of the elements of an insurance-like approach to investment strategy which may benefit a DB scheme.

Credit-the benefits of going global

With allocations to corporate bonds set to increase for UK pension schemes, Lionel Pernias, AXA IM’s Head of Buy & Maintain Credit Strategies in the UK, outlines the rationale for diversification into the global credit market.

 Challenges Ahead

Pension schemes with LDI strategies face two main challenges: the short supply of suitable de-risking assets, and the regulatory impact on financial institutions and the instruments used commonly in implementing LDI. Jonathan Crowther, Head of UK LDI, considers how these challenges negatively impact the costs of de-risking and discusses schemes’ governance needs when navigating these structural challenges.

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