20 October 2022

FT: A different perspective on LDI

UK defined benefit pension schemes have never been in better shape thanks in large part to the investment strategy by Abdallah Nauphal - The writer is chief executive of Insight Investment

It is still early to talk about the crisis in the UK pension fund industry in the past tense, often a prerequisite for rational discourse. Nevertheless, I feel compelled to advance an alternative perspective on recent events. Polemics against the “liability driven investment” approach by pension funds seems to have overlooked some fundamental points.

The objective of a defined benefit scheme is to secure members’ benefits. On this measure, such funds have never been in better shape. In aggregate, DB pension schemes now have a funding surplus partly due to the discipline imposed by LDI. UK trustees and the Pensions Regulator have done a good job, better than almost anywhere else, in protecting the interest of members.

It is no coincidence that countries adopting a liability focused approach (the UK and Netherlands) have among the healthiest DB plans in the world.

In its essence, LDI is simply about putting the liabilities of a DB scheme — paying pensioners — at the heart of its investment strategy. This is a shift from traditional approaches that focus exclusively on the returns on the asset side of the balance sheet. A scheme would hedge the inflation and interest rate risk of its liabilities using leverage to free up capital to invest in high-quality securities that pay a premium over gilts, such as corporate bonds or asset-backed securities.

This allows the scheme to generate extra income and improve its funding position with a great degree of confidence. Even accounting for recent events, LDI has substantially reduced the volatility of schemes’ funding statuses, improving the certainty of meeting pension promises. If DB schemes are in good health, what is the problem? The current crisis stems from a mismatch between the liquidity of the assets of funds and the collateral requirements of the hedges....

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