P&I: What are the most common questions or issues that potential or existing LDI clients have?
Lapierre: I think a lot of plan sponsors want the best of both worlds. They want to be able to hedge their risks at the lowest cost possible, which is normal. But given that rates are so low, they're looking for ways to enhance the performance of their fixed-income risk, or they're not even willing to invest in fixed income. So they prefer not to hedge their risks because they feel that the costs are too high and instead, they're taking on other risks. We address this by going back to the basics and educating people as to why they're doing LDI — they're doing this because they've got this big liability that's taking a lot of risk. Their liabilities are valued right now, so it's really a matter of how much of your liabilities you want to get off of your balance sheet, essentially through a hedging strategy. And again, how much risk are you willing to take over and above that?
Veerman: Certainly, the level of rates comes up a lot. What we say is that interest rate risk for a corporate DB plan is an uncompensated risk; so, arguably, a plan sponsor should be agnostic on the level of rates. At a minimum, when you look at your risk budget, consider taking more risk in equities than in rates, which often means utilizing strategies such as high-quality corporate bonds, long government bonds, STRIPS and potentially interest rate derivatives. The expected return-on-assets dilemma, when moving from equities to fixed income, certainly at the [chief financial officer] level, is a significant headwind. We are the world's largest active equity manager, and our analysts often factor in pension risks when making decisions about companies they invest in.
People shouldn't stop their derisking because of the short-term implications on earnings, so that's a common discussion.
Maybe people don't ask this enough, but how do they appropriately communicate overall LDI program success? We know it's not looking at your 3% allocation to your emerging equity manager and seeing that they're 30 basis points under [benchmark] and talking about whether you should keep them or fire them for the next 45 minutes of a committee meeting. It's really about what drove your funding outcomes. How hedged were you, and did the hedge do its job? And then not doing an asset-liability study every committee meeting, but having risk metrics to evaluate if you're still comfortable with the amount of potential downside risk you're taking as an organization. An LDI program is only as good as your ability to communicate it.
Stapleton: Most of the conversations that we have revolve around the conflicting desires of mitigating your funded status volatility while maximizing your return. Obviously, you can't do both. So what you have to do is really establish a strong glidepath strategy, and that includes all those risk metrics that we were just talking about. It's not just about returns and how much you have in fixed income, but what is your key rate duration mismatch, what is your equity volatility drawdown exposure and having that be front and center, so everybody understands what's on the table. If you don't have everybody educated, it's going to be very difficult to get buy-in and support on a continuous basis because you're going to have short periods of underperformance versus benchmarks, and that's not what materially matters. It's all about risk management and matching as an [asset-and-liability management] problem. That's what everybody should have as a goal. It's more [focused on] long-term investment and risk management.