Increasingly, many institutional investors are realizing that it is essential to set investment policy with an eye toward the value of their liabilities. Liability-driven investing (LDI) is a framework for understanding the nature of liabilities and, ultimately, for developing an investment strategy that considers assets and liabilities jointly.
LDI is not a product. Rather, it's a continuum of services and solutions that can be customized based on factors such as funded ratio, existing and projected liabilities, investment beliefs and constraints, and broader long-term objectives.
The Client Solutions team uses the firm's full range of investment capabilities, strategies, and vehicles to help plan sponsors construct Liability Hedging solutions tailored specifically for their needs. For those plan sponsors who are looking to exceed liabilities, we offer the full range of Liability Plus solutions. This includes Journey Management and the implementation of dynamic, multi-asset portfolios, as well as comprehensive Fiduciary Management Services, where we assume accountability for recommending, setting, and implementing investment policy.
LDI Frequently Asked Questions
- What has changed? Why should I be interested in LDI right now?
- What goals should I be setting in this environment?
- What pitfalls should I avoid?
- How do I achieve my goals in a dynamic market environment?
- How do I get started?
Pension plans formerly operated in an environment in which liability values were rarely marked to market, and where smoothing and deferred recognition were the norm. But much has changed. The size and scope of today's plans often overshadow the resources dedicated to managing them. Mature plans may be closed or in various stages of run-off. Accounting and pension funding rules have also translated their mark-to-market asset-liability (i.e., surplus) risk onto their plan sponsors via balance sheet and cash-flow requirements. Further changes to income statement recognition are also expected. All the above contributes to a more risk-aware environment than ever and an increased appetite for a liability-driven investing approach. The inadequacies of past approaches are seen in the current poor funded ratios of most pension plans.*
Read this brief article for an overview of the announced changes and hear from three of BlackRock's LDI and accounting experts on the broader implications.
This monthly report discusses the current funded status for corporate pension plans (for the median U.S. plan's reported or accounting funding ratio).*
Learn more about the implications of this legislation for corporate pensions. Written by Barbara Novick, Andy Hunt and Dan Ransenberg.
To achieve pension plan investment goals, investment risk should be spent wisely. LDI seeks to make the best use of any investment risk budget by focusing on the risks that are deemed most rewarded as well as those likely to help improve the plan's funded status, while simultaneously reducing unintended or unattractive risks. In short, risk measurement and management are the backbone of any liability-centric framework. The secret to a successful LDI approach is bringing together investment opportunities, costs, and risks—a tall task.
Charter Portfolio design starts with setting unique, relevant, and clear outcome-based investment goals to break away from the standard paradigm.
Many sponsors are setting goals focused on their required contributions. Discover a four-step plan that can help you manage your bond portfolio with cash contributions in mind.
Not all LDI strategies are created equal. Plan sponsors should watch out for four potential shortcomings:
- Too often, LDI strategies may focus narrowly on matching a slice of the plans assets (typically, the fixed income assets) against a slice of the liabilities, which can underrepresent both the opportunity set and the total risk. A total asset and liability assessment of risk and return should drive the focus of LDI.
- Don't confuse exposures and capital, since that can lead to suboptimal implementations. We prefer to consider exposures as the primary investment objective, and capital (i.e., the assets of the plan) as the means to support the exposures. The benefit is greater investment efficiency.
- "Set-and-forget" LDI strategies may fail to keep abreast of—and to readjust and react to — changing opportunities and needs. LDI is a long-term, evolutionary investment approach. An ongoing dialogue and partnership culture between a plan and its LDI manager can help keep that strategy on track.
- Beware of performance reporting that fails to adjust to reflect the LDI strategy. The flow of performance reporting and attribution should reflect the basic tenets of LDI — reporting should highlight areas of residual risk, to help focus on potential improvements.
Corporate yield curves for discounting pension liabilities can lead to a “matching portfolio” that invests heavily in bank bonds at an inopportune time.
Four approaches to managing downgrades of corporate bonds could have increased a pension plan's funded ratio by 14% over the past 20 years.
Interest rate movements are the primary risk factor for pension plan members and fiduciaries.
Should plan sponsors implicitly assume the ability and authority to make large interest rate bets?
Pension plans should have a clearly articulated goal (e.g., improve funding status by x% over x time period). Once the plan vision is clear, oversight of pension plans should be sufficiently flexible to ensure timely reaction when necessary. Journey Management is a term we use to refer to investment strategies that focus on a goal, incorporate new information, and react in real-time to help achieve better outcomes.
Pension plan surplus risk management needs to be improved. We suggest three strategies that can bring significant improvements without adding an undue amount of complexity or cost.
How dual-beta strategies can help solve the low risk/high return challenge faced by many defined benefit plan sponsors.
Read this article to learn how interest rate swaptions can help pension plans move closer to their LDI goals.
In this follow-up article, we elaborate on a framework for managing risk that is responsive to volatile market conditions, and we illustrate how to do this through a case study.
This introduction to Journey Management explores a dynamic approach, focused on achieving clearly defined outcomes.
BlackRock provides comprehensive LDI services. To learn more, contact your BlackRock Account Manager, or email the LDI team.
We illustrate how LDI turned around one corporate pension plan's Defined Benefits plan.