How has liability driven investment (LDI) performed over the past five years?
- Gerry Degaute, chief executive, Royal Mail Pension Trustees
- Chris Atkinds, managing director, Atkins Trustees
- Shalin Bhagwan, head of structuring, Legal & General Investment Management
- Russell Chapman, partner, Hymans Robertson
- Steve Jones, director, Capita Pension Trustees
- Mark Humphreys, head of UK strategic solutions, Schroders
- Peter Drewienkiewicz, head of manager research, Redington
Chris Atkins: I have some difficulties in defining what successful means in terms of LDI because you’re just trying to match your assets and your liabilities in a specific way. If you do that then you’ve succeeded. You tend to measure success via reference to what would have happened if you hadn’t done it.
Degaute: It is a vehicle for buying insurance and at a price. If you look back and say you bought your insurance at something that is far less than today, I guess you feel quite good about it.
Pete Drewienkiewicz: Shouldn’t we try to separate the question of success from the market moves we’ve seen? If we look at the past five years then you’re absolutely right; anyone who was a relatively early adopter of LDI probably feels it’s been extremely successful for them because yields are now a lot lower than they were. But you try to separate it from the way we’ve seen markets move. We try to say, ‘Has that way of thinking been a success?’ And you would probably have to say yes, it has.
Mark Humphreys: That has been its greatest success – making people think about a scheme’s assets and liabilities in their entirety. This is really looking at a scheme in a different way.
Degaute: I agree it is a way of thinking and perhaps what you mean by that is we bought something else in the process. That something else was the management of liability as opposed to assets, so that made us focus more on risk – a risk embedded in what we have to face as opposed to a risk we can take and seek more return.
LDI to a certain extent has been obliged upon us because of the mark-to-market world we’re in, so we have to worry about the volatility far more than we used to, where we could take the return-seeking assets and just smooth them at the point of becoming depressed. In fact they can smooth down the upside as well.
Russell Chapman: The big success has been around understanding and people have acknowledged they’re facing this big risk, which has really woken them up to managing the risk in some sense.
The point about smoothing is quite interesting because if you look at a number of schemes that have got quite developed LDI programmes, it’s actually acted on the investment side to smooth out returns. Typically, when things have gone badly, your LDI portfolio has delivered and that has meant overall investment returns – not in a matching sense but in a total return sense – have been smoothed, which is not what it’s meant to be, but it’s been a by-product of the way markets have gone.
Q If yields were a lot higher than they are now – much higher than they were in 2006 – would you still say LDI had been successful?
Degaute: The answer is yes; the focus was to manage liability, so once that’s agreed by trustee and company, that’s the thing to do because in that sense it’s taken the risk off the books. I’m talking with the benefit of hindsight and so yes, it gave early movers better returns overall but the driver was management of risk, not added return.
Shalin Bhagwan: If yields were higher it would actually be a good thing. Clients haven’t put all their eggs into the LDI basket. By no stretch of the imagination have the majority of UK pension funds reduced all their exposure to interest rate and inflation risk, which are two big risks LDI really tries to manage. Higher yields would actually allow the unhedged liabilities to fall in value and give people the opportunity to take that risk. It’s a phased approach that clients have tended to adopt.
Atkins: Now we have low yields it makes LDI expensive. But anybody who comes into LDI at this point are assured success on the criteria they’ve set because they’ve done it on the basis that they want and need to take risk off the table. Therefore it’s almost self-evident it must be successful because that’s what you’re trying to achieve and you’ve achieved it by doing it. So it’s sort of a silly question.
Chapman: What’s happened for those schemes that haven’t done a lot, or haven’t gone that far down the route, is they are now in a position where the risk is still too big. It’s still disproportionate in relation to anything else they are facing and that gives them a difficult decision – shall we continue to run a risk that’s too big for us or shall we take it out, insuring it at a cost that we think is too expensive?
Atkins: On a risk-valued asset we’re obsessed with capital value and changes in capital value. But in LDI we’re looking at income and putative benefit flows. When you invest in equities it’s all down to the market standing at 5,000, not what’s happening to income from those securities. And we’ve got this imbalance between looking at fixed interest or inflation-linked equities. Maybe we should be moving towards looking at equities the way we looked at cash flows and actuarial valuations years ago, which was on the basis of future cash flows. Now we don’t tend to do it; we’re obsessed with the short-term volatility in equity markets.
Steve Jones: Certainly trustees should be having debates so they understand that if the window is open and it’s an appropriate time, they can go into some of these strategies.
Drewienkiewicz: Yields are of course very low, so maybe the offshoot question is what relevance does LDI have when rates are so low? You might not necessarily want to do something straight away but if you can put in place a sensible risk-management framework that’s going to allow you to take risk systematically off the table at certain levels and at least put in place the governance structure to allow you to act at appropriate times and act rapidly, then that in itself is a massive evolution and a big step forward from where we were five or 10 years ago.
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