Capital Group making a serious play for LDI

Capital Group Cos. Inc. hired a top liability-driven investment executive — a former key player from BlackRock Inc., one of the largest LDI players in the U.S. — to spearhead the expansion of its own LDI business.

Gary Veerman, Capital Group's new head of LDI solutions, joined Cap Group in October, attracted by the opportunity to build his new firm into a major LDI player. At BlackRock, he was a managing director and head of U.S. LDI solutions from 2014 to early 2017.

In an era when many active managers have seen outflows to passive shops, LDI is seen as an area of growth for money managers. LDI strategies are typically used by corporate defined benefit plans, which are often closed to new participants and frozen, to manage risk. As plan funded status rises, a common LDI investment strategy is to replace equity exposure with long-dated bonds to reduce market volatility and to ensure current and future plan liabilities are paid.

BlackRock is ranked third in the U.S. LDI market, with $71.2 billion in assets under management in LDI strategies as of Dec. 31, 2016, show Pensions & Investments data.

A BlackRock spokeswoman, who declined to be identified, said after Mr. Veerman's departure the company had promoted Matthew Nili to managing director and head of U.S. liability-driven investing. Mr. Nili had been a team member on BlackRock's client solutions team, on which he still serves.

BlackRock CEO Laurence D. Fink said in an earnings call with analysts on Oct. 11 that BlackRock saw $37 billion in institutional fixed-income inflows in the three months ended Sept. 30, which were "driven by significant client demand for LDI strategies."

By comparison, Capital Group is a relatively small LDI player with $6.8 billion in LDI assets under management as of Dec. 31, show P&I data. (The top two U.S. LDI managers were NISA Investment Advisors LLC with $97.4 billion and PIMCO with $94.8 billion, P&I data show.)

While Capital Group is ranked 18th in the P&I data, Mr. Veerman said his new firm is committed to building scale and joining the ranks of much larger LDI managers. Capital Group, never has had a senior executive dedicated to running LDI strategies prior to Mr. Veerman. Capital Group officials say LDI previously was handled by an investment committee. But the firm has run LDI strategies since 1998 and Mr. Veerman said he is taking over at an organization that ​ he is taking over at an organization that has already been successfully running those strategies.

"If you have got the blocking and tackling done correctly — the fundamentals right — then you're on the right track to building a successful business," he said of Capital Group's LDI business.

Consultants to institutional investors say they expect liability-driven investing to grow for a number of reasons in coming years. The equity bull market has helped increase the funded status of corporate pension plans and sponsors want to take advantage of those increases by taking an LDI approach.

Another issue is planned premium increases by the Pension Benefit Guaranty Corp. on unfunded corporate plan liabilities. That premium, less than 1% per $1,000 of unfunded liability several years back, is now 3.3% and scheduled to go up to 3.7% in 2018 and 4.1% in 2019.

"If your plan is underfunded by say $50 million, you can transfer $50 million to the plan and you get a guarantee or an automatic return of 3.3% on those assets because you don't pay that premium," said Kevin Armant, a senior consultant in the financial strategy group at consulting firm, Mercer LLC., Princeton, N.J.

Mr. Armant said the Republican tax plans in Congress are also renewing interest in LDI strategies. Mr. Armant said a reduction in corporate tax rates could potentially reduce the deduction that sponsors receive for contributions to 20% from the current 35%, encouraging sponsors to accelerate the payments before tax laws change. Sponsors could then use LDI strategies to manage the risk of the higher-funded pension plans, he said.

If interest rates rise as expected, corporate pensions that embrace a new LDI approach and increase fixed-income exposure could see a rise in their funding ratios, which some consultants say could sway some companies now on sidelines to adopt an LDI approach.

Capital Group's LDI push is part of overall efforts to build the firm's fixed-income franchise, an effort that intensified when the firm hired Michael Gitlin, T. Rowe Price Group Inc.'s head of fixed income, in January 2015, said Ralph Haberli, sales director for Capital Group's institutional retirement segment who joined Capital Group in 2016, also from BlackRock.

Capital Group is one of world's largest asset managers, with $1.7 trillion in assets under management, as of Sept. 30, company data shows. But while rising equity markets have helped build AUM in recent years, the firm has been not immune to the net outflows that other active equity managers are facing.

However, the manager has been bucking trends in 2017. In the 10 months through October, Capital Group mutual funds had net inflows of $13.7 billion, shows Morningstar Inc. data.

While the firm remains committed to its active equity approach, Mr. Haberli said it also is intent on building its $300 billion fixed-income franchise as part of an asset diversification plan. Capital Group statistics show that fixed-income AUM was $224 billion as the end of 2014, before Mr. Gitlin arrived. It rose to $263 billion at the end of 2016 and to $300 billion, as of Nov. 19.

Mr. Haberli said Capital Group had been exploring building its LDI business for the last 18 months.

Mr. Veerman said Capital Group offers a strong LDI proposition to institutional investors, based on the money manager's strong longer-term investment results in its long-duration bond strategy, a key building block for LDI strategies.

For the year ended Sept. 30, the strategy underperformed the Bloomberg Barclay's U.S. Long Credit index, returning a net 2.61% vs. the benchmark's 2.88%, show company statistics. On a three-year basis, the 7.18% net annualized return compared to the benchmark's 5.98%; for five years, it had a 5.49% net annualized return compared to the benchmark's 4.71%.

Mr. Veerman said pension plans increasingly want customized LDI strategies and he believes his background at BlackRock — plus his previous experience as head of LDI strategy at Legal & General Investment Management America and director of asset allocation research at institutional consulting firm Rocaton Investment Advisors — will help attract new LDI business to Capital Group. Mr. Veerman said he also will be hiring two LDI strategists in coming months to build out Capital Group's efforts.

Just how successful Capital Group could depend on how different its LDI investment approach is from competitors, consultants said. While not commenting specifically on Capital Group, Jeffrey Stakel, a principal with money manager consulting firm, Casey Quirk by Deloitte, said it's hard for firms to compete with managers already dominating specific strategies unless they can offer something unique. "The value proposition has to be clear and compelling," he said.

Mr. Stakel said approaches such as LDI can help managers build and retain assets because it is not a specific product but a solutions-based offering that involves extensive conversations about investment outcomes. He said those relationships tend to be broader that one product, meaning that the assets invested with a manager are more "sticky and last longer."

Statistics from eVestment, Marietta, Ga., show that $378.3 billion was invested in worldwide institutional LDI strategies as of Sept. 30, down from $415.9 billion a year earlier. But the statistics also show net inflows of $31.8 billion in the three months ended June 30 and $7.4 billion in the three months ended Sept.30.

Dan Lomelino, head of North American and multiregion fixed-income manager research at consulting firm Willis Towers Watson PLC, said risk transfers — in which a plan sponsor can transfer some of the pension plan's liabilities to an insurance company — can reduce the amount of money in LDI strategies during a specific period.

Still, the Chicago-based consultant said given the flight from active strategies generally, LDI is a way for managers to grow assets. "For the foreseeable future, there is going to be a desire for LDI," he said. But he also cautioned that the LDI market is mature and "it's not the easiest place to grow (manager) market share."