www.the-actuary.org.uk
W
hen liability driven investment
(LDI) first emerged within
pension schemes, there
was a widespread lack of
understanding and, in some cases, suspicion
around what these solutions were doing
and whether they actually helped.
Over time, LDI has become more
mainstream, with greater knowledge
and acceptance among institutional
investors and increasingly of more
sophisticated solutions.
In the beginning,
was the (buzz)word
LDI can be defined to encompass a broad
approach but typically involves hedging
the impact on liability values arising from
changes in interest rates and inflation,
usually through swap contracts. When LDI
first emerged in this form, a typical strategy
might have been:
n A large, segregated portfolio
n Fully cash flow matched
n A low risk, low return strategy
n Best for fully funded, closed, mature
schemes, or just pensioner liabilities
n In a very small minority
n Expensive to implement, both in terms of
transaction costs and in terms of the rates
that are locked in.
Many of these things may have been true,
and they certainly restricted the potential
audience. However, they were also reflective of
a product in its infancy and a long way from
reaching its full potential. Over the past five
years, LDI fund managers have set their minds
to overcoming some of the drawbacks of early
solutions, with far-reaching success. The LDI
solution of today is much more applicable to a
wider range of situations.
Pools of buckets
The first major breakthrough occurred when
fund managers launched pooled funds.
The responsibility for negotiating with
investment banks over the documentation
required for swap contracts was shifted
from pension schemes to the fund manager.
The need for a segregated account, with
associated costs, hassle and minimum size
restrictions fell away.
In designing pooled funds, managers
adopted a `bucketed' approach (see Figure
1), whereby each fund addresses the risks
associated with cash flows in a number
The rise and rise of LDI
Ross Pritchard examines how liability driven investment solutions have become
more sophisticated to meet the needs of pension schemes
Investment LDI
28 October 2008
Figure 1: `Bucketed' LDI approach to pooled funds
2008 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 2078 2083
�LDI fund managers have
set their minds to overcoming
some of the drawbacks
of early solutions �
Ross Pritchard is an LDI
solutions manager at
Schroder Investment
Management
Fixed cash flows
Pooled hedge -- nominal
Index-linked cash flows
Pooled hedge -- inflation
12 000 000
10 000 000
8 000 000
6 000 000
4 000 000
2 000 000
0
-2 000 000
-4 000 000
-6 000 000
-8 000 000
-10 000 000
-12 000 000

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