Liability driven investing introduction to sociology

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For the past 20 years pension trustees and their consultants have determined their own objectives and investment mix — and therefore the amount of exposure to LDI strategies — while asset managers have advised on how to structure and implement those strategies on behalf of their clients.

Working together they adjust these strategies as market conditions change, so that they continue to meet the objectives of the defined benefit pension plans. What has happened? As yields increase, so bond prices decrease in value, meaning asset managers like BlackRock periodically inform pension funds that if they wish to keep the same exposures, they will need to increase the assets in their LDI strategies.

As UK government bond yields have been rising throughout , asset managers have made such requests dozens of times this year, with the majority of trustees and consultants wanting to maintain the same level of exposure. The process takes several days to run, typically more than a week from start to completion. Normally, adjustments to the required assets fluctuate gradually over time, and the amount of excess assets is more than enough to cover requirements based on previously observed market moves.

However, due to the extraordinary moves in UK rates and inflation-linked bond markets in a short space of time at the end of September , swift action was needed to protect LDI strategies. To put that in perspective, the increase in year gilt yields was more than three times larger than any other historical move over the same period.

What happened from September 23 — up until the point that the Bank of England announced it would buy long-dated UK government bonds to stabilise the market — was that markets were moving so fast that there was simply not enough time to get the required assets into the LDI strategies given how long that process takes.

This resulted in managers asking funds to consider increasing the excess assets in their strategies — a process known as recapitalisation. The amount of cash needed rises and falls in tandem with values of the underlying assets tracked by the derivatives, which are a type of 'insurance' contract for guarding against unexpected moves in markets.

Rocketing rates. Interest rates have been inching higher for months as central banks hiked borrowing costs in a well-flagged manner, giving pension funds time to adjust and find collateral over several days. But when UK bond yields rocketed in just a few trading sessions, it triggered emergency collateral calls for pension funds to cover their LDI-related derivatives in a matter of hours, as rising yields mean the value of bonds falls.

Pension funds struggled to find the cash in such a short time, forcing some to sell gilts, thereby putting further downward pressure on the bond market. To manage the instability in markets, the Bank of England has pledged to buy gilts worth 65 billion pounds in a scheme designed to take pressure off the pension funds. But volumes actually purchased have been modest. On Tuesday, the Bank of England bought just 1.

Not just yet. Even after several Bank of England interventions, including a decision to extend the emergency bond-buying programme to include index-linked gilts, the task facing pension funds is intensifying - partly due to fresh collateral calls on newer hedging strategies.

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Liability-driven investments provide cash flow to cover liabilities, like how much a retiree needs to withdraw each year from retirement accounts for living expenses. Instead, the approach focuses on acquiring assets that will ensure current and future liabilities are met. For example, while the primary goal of a mutual fund manager is maximizing returns, the sole responsibility of a pension fund trustee is ensuring that current and future payouts promised to beneficiaries are made.

LDI Strategies for Individuals vs. Individual investors may adopt the approach to meet specific cashflow needs in retirement. An individual using the LDI strategy will likely compile a bond-heavy portfolio to match their cash flow needs. A defined benefit pension plan, however, may employ more sophisticated investing strategies, like hedging through options and swaps.

Long-term bonds are a common liability-driven investment, but in a low-interest environment more illiquid assets like real estate and infrastructure may also be viable options for pension plans and individual investors, alike. Because LDI seeks to mitigate risk, returns on these types of portfolios are typically much lower than portfolios that are more heavily invested in equities. By investing in long-term bonds or other assets with less risk than stocks, an investor forgoes the potential rewards that accompany equities.

Our clients include defined benefit pension plans, which must manage their investments so that when their members come to retire, they can pay out sums that meet their expectations. In recent decades we have been in an environment of low and falling government bond yields in the UK. This has been especially important in the low-rate environment given how little yield has been available from investing in government bonds.

But the value of future pension payments is prone to fluctuations in the rate of measures such as inflation and government bond yields, requiring pension plans to mitigate, or hedge, those risks if they can. The idea at the core of LDI strategies is that a pension plan can match the value and time horizon of its current assets to its future liabilities, while freeing up capital through borrowing to invest in growth assets.

For the past 20 years pension trustees and their consultants have determined their own objectives and investment mix — and therefore the amount of exposure to LDI strategies — while asset managers have advised on how to structure and implement those strategies on behalf of their clients. Working together they adjust these strategies as market conditions change, so that they continue to meet the objectives of the defined benefit pension plans.

What has happened? As yields increase, so bond prices decrease in value, meaning asset managers like BlackRock periodically inform pension funds that if they wish to keep the same exposures, they will need to increase the assets in their LDI strategies. As UK government bond yields have been rising throughout , asset managers have made such requests dozens of times this year, with the majority of trustees and consultants wanting to maintain the same level of exposure.

The process takes several days to run, typically more than a week from start to completion.