While liability-driven investing (LDI) has achieved some measure of celebrity over the past year, the concept still has a reputation for being of interest only to egg-heads and actuaries (apologies to egg-heads…okay, and actuaries).
About a month ago, consultancy Mercer wrote:
“It seems like only yesterday that Liability Driven Investing (LDI) was an interesting academic idea with few “real world” proponents among pension plan sponsors. Now, LDI regularly makes the front page of pension industry publications and is widely accepted as a practical and effective risk management framework. Plan sponsors implementing LDI strategies were “mavericks” only a few years ago; now they are “cutting edge.” For such a new area, LDI seems to have more than its fair share of experts. And there is a surprising diversity of opinions on what it is and what best practices are.”
The pace of change seems to be accelerating. Poll results released last Friday by SEI Global Institutional Solutions show that the simple, traditional definition of the concept, “matching the duration of assets to the duration of liabilities” is giving way to a more holistic view that LDI is “a portfolio designed to be risk managed with respect to liabilities.”
Although this sounds like the same definition delivered by a marketing person instead of an actuary, SEI says this “suggests a stronger understanding around the broader implementation of LDI”. Curious about whether LDI was having a break-out year, we requested a copy of the full report. Here’s some of what we learned…
This broader definition of LDI (“risk managed…”) has taken hold in the UK and Canada, but not in the US, Netherlands or Hong Kong where pension executives still say LDI is still just about matching the duration of assets and liabilities. This isn’t’ to suggest that the Dutch, for example, remain ignorant about the potential of LDI – fully 62% of pensions there use it (vs. around 40% for other countries polled).
While their definitions differed, US and UK pension funds agreed on one thing though – LDI is here to stay. The percentage of plans using the approach doubled in both countries over the course of 2007. In fact, as the following chart, build with data from the report, shows, more pensions are implementing LDI while fewer are not considering it (the remainder, we assume, are considering its implementation).
Why the excitement? Apparently it’s not just because recent abysmal returns have forced pension plans to revisit their strategies. In fact, “poor investment performance” ranked as only the fifth most important reason why plans have flocked to LDI. The reason, it seems, may be that investment consultants (the reformed egg-heads and actuaries) have the ear of the pension community. The following chart showing what factors are influencing changes in pension asset allocations (also created from data in the full report) suggests that consultants and their immediate clients (boards and committees) are driving the LDI agenda:
The bottom line, says SEI…
“The biggest change over the past year appears to be that pension sponsors are no longer in the “understanding phase” when it to comes to LDI and are now entering the “implementation stage.”