U.K. firms working to enlist U.S. LDI clients

U.K. money managers are putting their U.S. fixed-income acquisitions to work, hoping that local presence will help them to get a foot in the door at U.S. pension funds in order to introduce their form of LDI.

Derivatives and other synthetic instruments are commonly used by U.K. pension funds implementing liability-driven investing. In the United States, however, pension fund officials more often employ physical securities to hedge liabilities, consultants say.

“I have spoken with U.S. and U.K. shops and (there is recognition) that the U.K. way is a superior way to do it,” said Chris Redmond, London-based global head of credit at Towers Watson & Co. “We have been considering this for four or five years, but to date, generally, it has been met with resistance” in the United States.

A survey by SEI Investments of 130 corporate pension executives from the U.S., Canada and the U.K., published December 2013, found 57% of global plan sponsors are using LDI strategies. For U.S. survey participants, 71% have an LDI strategy in place. By assets, 49% of global respondents' portfolios on average, are allocated to LDI strategies. Among U.S. and Canadian plans, 72% of those strategies use long-duration bonds as a hedge.

But before even beginning to talk to U.S. pension executives, U.K. firms need to build or — as in the recent cases of Insight Investment Management (Global) Ltd.'s parent company, BNY Mellon Asset Management, and Schroders PLC — acquire the expertise and necessary track record in U.S. credit management.

“In the U.S., LDI rightly or wrongly has become synonymous with managing credit,” said Gordon Fletcher, partner at Mercer Investments in New York. U.S. plans use credit-based discount rates — a significant difference to the U.K.'s largely gilt-based discount rate. “And so to really just get your foot in the door, you need to have some demonstrable track record in managing credit. If you don't have that, it is very difficult to even have conversations with U.S. pension plans. Those looking to set up shop in LDI need to acquire that expertise or build it up or buy a company with that expertise.”

Acquisition also adds scale, an important element, said Jeffrey Stakel, partner at money management consultant firm Casey, Quirk & Associates LLC, Darien, Conn. Scale is “essential when it comes to building a profitable LDI business.” An acquisition is also a faster way to get a local footprint. “Currently, there is a lot of money on the sidelines, and LDI managers expect those assets to flow into the system as rates rise. If this happens before a manager has gained traction in a new geography, they may be too late.”

Crafting its capabilities for a U.S. audience is something U.K. manager Insight is now considering as it moves to offer LDI in the U.S.

“There has been demand from investors for us to offer LDI in the U.S., and our corporate owner has long expressed an interest in providing a support to Insight to expand our offering to U.S. institutions,” said Serkan Bektas, co-head of solutions design for Insight in London.

Thus far, the manager has been talking to U.S. pension plan executives through its European and U.K. clients with U.S. subsidiaries.

But demand is growing, said Andrew Giles, Insight chief investment officer-solutions and member of the executive management committee. “There now seems to be an appetite for (LDI) firms that have a different offering. That is a pull from the clients to give them an alternative to what is currently long duration, corporate bond management.”

What has hindered Insight's ambition is this necessary experience and expertise. “What has held us up a little is not having a strong U.S., domestic long-duration fixed income capability,” said Mr. Giles.

But that is set to change. Insight parent BNY Mellon Asset Management announced in October that it is acquiring U.S.-based fixed-income specialist Cutwater Asset Management — and with it, a 20-year track record in long-duration and other fixed-income strategies.

“Cutwater will tick two key boxes for us — filling the prerequisite of having a top-rated domestic fixed-income capability with a very good track record,” said Mr. Giles.

With U.S. plans open to a conversation, consultants say there is opportunity for newcomers.

“Where there is space for new entrants is providing a more holistic, comprehensive and sophisticated risk management offering,” said Mr. Fletcher. “We tend to think of LDI as quite a narrow offering: just hedging liabilities. If you can have managers that are able to look at the balance sheet as a whole, do liability matching but also ... manage risk on the growth side,” that is an opportunity.

The U.S. way of conducting LDI “necessitates an asset allocation decision to buy bonds, which may not fit with the strategic portfolio return targets,” said Mr. Bektas. “Our experience of creating synthetic exposures and enabling funds to stay invested in growth assets will be a source of differentiation.”

By using synthetic instruments alongside physical securities to create hedges, “you can have your cake and eat it,” too, said John McLaughlin, London-based head of investment solutions at Schroders.

Schroders acquired U.S. fixed-income specialist STW Fixed Income Management LLC in April 2013 and is now looking to leverage that acquisition as it builds its multiasset and portfolio solutions business in North America, by bringing U.K.-style LDI and risk management to the U.S.

There are two core elements: personnel and STW's experience in physical LDI, which Schroders will use to guide its incremental development of LDI in the U.S., but STW's “alpha engine will always be its beating heart,” said Mr. McLaughlin. Schroders hired Seth Finkelstein in June as U.S. product manager, portfolio solutions, within the firm's multiasset and portfolio solutions business. (He was previously senior vice president and client portfolio manager at ING Investment Management, now Voya Investment Management.) Daniel Morris, LDI solutions manager, will move to New York from London next year to launch the portfolio solutions unit in the U.S.

On top of the manager's standard LDI approach — actively managing long-duration bonds against markets benchmarks — it can leverage STW's liability-cognizant investment offering, creating customized liability benchmarks. Then, for certain pension fund clients that are more mature, well funded or need more precise cash flow matching, it can include a “satellite” offering, which will “employ the derivatives technology and expertise that provides tighter liability matching, as in the U.K.,” said Mr. McLaughlin.

One U.K. manager that has successfully transported LDI to the U.S. is Legal & General Investment Management (Holdings) Ltd., via its LGIM America business. And it did so without acquiring a business.

“In bringing an LDI offering into the U.S. market, we got very direct feedback from U.S. consultants and plan sponsors that we needed to be highly conscious of what mattered to U.S. pensions and their consultants; they said we cannot just directly transplant the U.K. LDI mousetrap into the U.S. market,” said Tom Meyers, Chicago-based senior client portfolio manager at LGIMA.

The firm built two components in the U.S. — a U.S. fixed-income team and a separate solutions group. “Having a local team ... is an essential starting point for an LDI offering in the U.S.,” Mr. Meyers said.

The manager has amassed $30 billion in external assets, with about $26 billion of LDI assets, in four years, starting from nothing, said Mr. Meyers. n