There’s little question that portable alpha and liability-driven investing (LDI) have captured the attention of the world’s pensions over the past 5 years. But while pension funds are attracted to the results of such strategies, they can be turned off by their complexity (related posting). As they say about sausages (and democracy), “Tastes great, but you sure don’t want to see how it’s made!”
Now Pensions & Investments reports that at least one LDI provider, ING, has offered to make the entire sausage itself. All the pension has to do is pull up a chair and enjoy those tasty links with their scrambled eggs.
This development was inevitable. It seems to be the natural evolutionary path of various business services industries. Services firms who begin life as consultants gradually morph into full-fledged suppliers of core business functions. For example, in the 1990’s, it gradually dawned on the consulting industry that if it was so good at creating efficiencies, why should it not just assume responsibility for entire business processes on a contingency fee basis. That way, they could profit from their own ideas, rather than simply provide them by the hour. I recall my own employer, a Big 5 firm, pitching the US Government on the operation of entire military and government installations.
Companies like consultant Bain & Co. added a twist. After spending decades increasing shareholder value for its clients, Bain figured it should just buy a few companies, apply their whiz-bang methodologies and profit from their own success. Thus was born Bain Capital.
Similarly, investment consultants became tired of watching their clients profit from their manager-selection research and advice. So these consultants began to creep into the fund of fund space (Frank Russell being one of the most prominent to do so).
More recently, suppliers of portable alpha solutions have become suppliers of soup-to-nuts portable alpha products (“bundled portable alpha”).
And now we see the introduction of what amounts to a “bundled” Liability-Driven Investing (LDI) solution. Continuing the time-honoured tradition of business services firms morphing from advisers into major outsource partners, ING announced last week that it was now in the business of providing not just the services and funds that help pensions stay solvent, but the guarantee that its pension clients will stay solvent. According to Pensions & Investments:
“ING executives are touting the new offering as an alternative to liability-driven investing, which aims to preserve a plan’s funded status usually by investing in low-return, less risky long-duration fixed income.”
Paul Zemsky of ING tells the newspaper that:
“…you’ll be no worse funded than you are today we’re taking the risk if we screw it up.”
Given the risk involved, it may come as no surprise that ING will initially target fully-funded pension plans when it goes to market in Q4. Fees are to be determined, but Zemsky told P&I that ING would keep about half of the upside as long as it maintained the plan’s pre-existing funding level.
Of course, someone needs to take on the risk that liabilities rise. If falling discount rates are the culprit, the product’s investment in zero coupon bonds and interest rate swaps acts as a hedge. But due to exogenous risks (like, say, someone finding a cure for cancer during the life of the guarantee), ING uses the services of an insurance company.
If this idea takes off, it would be a boon for the hedge fund industry. Hedge funds and funds of funds are often the preferred place to invest all that capital freed up by synthetic exposure to rates (view ING’s portable alpha pitch).
Like all structured products, this one requires a fee that can cover the cost of its underlying financial instruments and leave ING with a profit. The question is, do clients mind paying for the convenience and stability of guaranteed funding levels. After the pension funding fiasco of the past 5 years, we think they just may want to get out of the sausage-making business altogether.