In the U.S., meanwhile, corporate plans mainly hedge using long-dated investment-grade corporate bonds rather than derivatives or overlay strategies. However, Pensions & Investments data as of Sept. 30, 2021, reveals a number of U.S. plan sponsors have been making use of these derivatives-style hedges, too, including United Parcel Service, Exelon, Corteva, Deloitte, Target, KPMG and Eli Lilly.
As interest rates have risen, the notional value of some of the derivatives held in LDI portfolios has fallen. The result: increased collateral calls. The speed at which rates have risen means some pension plans have had to liquidate portfolios to meet collateral calls, according to the Investment Association's latest report in September.
Here's how LDI works: Liability-driven investing is employed by many pension funds to mitigate the risk of unfunded liabilities by matching their asset allocation and investment policy with current and expected future liabilities. The LDI portion of a pension fund's portfolio utilizes liability-hedging strategies to reduce interest-rate risk, which could include long government and credit bonds and derivatives exposure.
Jeff Passmore, LDI solutions strategist at MetLife Investment Management, said the situation with U.K. pension plans "has been challenging, and the heavy use of derivatives in the U.K. LDI model has made the current situation worse than it would otherwise be."
While most U.S. LDI portfolios rely on bonds rather than derivatives, '"those U.S. plan sponsors who have leaned heavily on derivatives and leverage should take a cautionary lesson from what we're seeing currently across the Atlantic."