LONDON — Often sold as a panacea for removing pension funds' asset and liability mismatches, liability-driven investing is more likely to relieve the symptoms than offer a cure, according to experts in the U.S. and U.K.
Certain types of risks can be hedged or managed effectively, but institutional investors should not count on LDI to solve all of their problems, said Nancy Everett, president and chief executive officer of New York-based General Motors Asset Management. GMAM manages $166 billion overall, including General Motors Corp.'s $114 billion pension plan, which launched an LDI investment framework in 2003.
Michael Peskin, New York-based managing director and head of the Global Pension Solutions Group at Morgan Stanley, added: "While almost all views on (LDI) are probably healthier than the paradigm that preceded it, it's not enough to care about certain risks, such as interest rate risk, and not pay attention to the rest of your portfolio."
Before the LDI movement, most corporate pension plan sponsors focused on maximizing returns on assets. But investment approaches that ignore the liability side are no longer viable in a mark-to-market environment because corporate plan sponsors could find themselves with heavy pension deficits that ultimately affect share prices, consultants said. As a result, many sponsors have implemented or are considering an array of strategies under the LDI umbrella that are aimed at better correlating their assets with liabilities. These range from an all-bonds strategy matching future liabilities to hedging interest rate risks while maintaining a higher-alpha underlying portfolio. But what they all have in common is a focus on risk management.
Not all LDI strategies are created equal, however, and the potential pitfalls can intensify rather than reduce the mismatch between assets and liabilities. These pitfalls include: not having enough alpha-seeking investments over time to cover funding shortfalls; ineffective ways of controlling certain investment risks under more volatile market conditions; and failure to recognize the shortcomings of LDI strategies, according to pension executives, consultants and managers.
Therefore, plan sponsors need to constantly revisit their investment strategies and fine-tune them so what they're doing still makes sense, said Andrew Dyson, managing director and head of institutional business for Europe, Middle East and Africa for BlackRock Investment Management Ltd., London.
"The concept of using derivatives and other strategies for hedging risk in terms of liability management is increasingly well understood," Mr. Dyson said. "The next stage is thinking about how you can create returns and manage the risk related to the creation of those returns in this framework."