If hedge funds became mainstream in 2004, is liability-driven investing the new kid on the block? In a surprisingly short space of time LDI, as it is now known, has come to the forefront as the next big thing to solve everyone’s problems.
There’s no doubting LDI’s newfound prominence. A recent survey from Mercer Investment Consulting found that liability-driven investment – along with hedge funds – is seen by asset managers as the biggest growth areas for pension funds in 2005. Mercer says LDI and hedge funds are likely to grow amid modest returns from mainstream equities and bonds.
While saying ‘I’m in liability investing’ may not have the same cachet as saying ‘I’m in hedge funds’, one thing is clear: asset managers are scrambling to get liability teams together and their product offerings to market.
“Over the last few months we have had meetings with several pension funds, in which our observation has been reinforced that there is a major paradigm shift taking place in pension asset management towards investing against a more explicitly defined liability-based benchmark,” says Jeroen Tielman at NIBCapital.
“Products defined in accordance with this approach face considerable interest. We will therefore intensify our efforts to develop liability-based investment solutions.”
Andrew Dyson, head of Merrill Lynch Investment Managers’ institutional business in Europe, says that liability driven investing meets a genuine need, but he’s concerned that there’s a “bandwagon” mentality developing.
“If there’s on thing our industry excels at it is jumping on a bandwagon,” he says. But he adds MLIM has seen a “huge explosion” of interest in the area in the last three to four months.
As MLIM says on its website: “We believe that by identifying the mistakes of the past, effective investment strategies can be created to manage a scheme’s liabilities. We have been working closely with schemes and their consultants to develop solutions tailored to their needs. In fact, we have already begun managing some assets for clients based on liability-driven objectives.”
Dyson adds as an aside that the growth of the liability-driven approach could mean that indexing – exemplified by firms like State Street and Barclays Global Investors – has reached its “high-water point”.
Interestingly enough, both firms have LDI products in the pipeline.
BGI says it is building up its LDI team and looking to launch its own pooled LDI solutions. It says: “Liability-driven strategies is a critical area for pension funds in the coming years. These solutions will enable pension funds of all sizes to explicitly and efficiently manage their liability exposures in ways that have previously only been available to the largest funds.”
Alan Brown, group chief investment officer at State Street Global Investors, says SSGA’s new pooled liability matching vehicle represents a “generational change”. The firm’s new ‘Pooled Asset Liability Matching Solution’ “enables pension funds to match their projected future liabilities within different inflation environments using a flexible and cost-effective pooled vehicle”.
“By recognising that liabilities, not market benchmarks, are the correct measure of a pension plan’s ability to meet its obligations to pensioners, we can more closely match the client’s liabilities over time, reducing the risk of over- or under-funding. “We expect this concept to grow in popularity because it places more investment control back in the hands of trustees.”
Paul Bourdon, director of investment solutions at Threadneedle Investments, says “ongoing regulatory upheaval has left pension and insurance funds in need of a new generation of investment products which combine long established asset/liability matching skills with increasingly recognised instruments such as swaps and structured credit products in order to meet their financial ambitions”.
“Liability matching has become far more than just a talking point and this is a great opportunity for fund managers, consultants, clients (owners and trustees) and banks to work more closely to bring appropriate solutions to the investment process.”
Nationale Nederlanden in the Netherlands has launched a new contract - under the slogan ‘keeping your balance sheet in balance’. The contract, in response to changes in the Dutch pensions market and new accounting standards, aims to guarantee the future pension obligations of a company or pension fund “regardless of market interest rate movements or the mortality rate”.
So, there’s no shortage of action.

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