"It seems like there have been improvements in terms of the amount of leverage and the way that collateral is used by LDI managers," said Gordon Shannon, partner, co-head of the investment-grade business at TwentyFour Asset Management.
The past year has seen a number of other changes for LDI programs, sources said — some unexpected and some still to play out — but overall, they agreed that pension funds have actually taken the opportunity to increase their hedges.
"We saw some (pension funds) increasing their hedge ratios," said David Rae, managing director and head of strategic client solutions at Russell Investments. "There were a few schemes that had been waiting for that opportunity — I don't think any anticipated it would arrive in the way it did. We didn't see any reduce hedges — many (trustees are) comfortable with the role" that LDI plays in a portfolio, he said.
Retirement plan consultant and administration firm XPS Pensions has also seen an increase. Analysis by the firm found that the average XPS investment client has increased its liability hedging by 3% between June 30, 2022, and June 30, 2023.
"Whilst we had the immediate questioning of the role of LDI (in portfolios,) in fact, most pension schemes have really stuck to their guns and we've seen a level of increased hedging, which means people are doing more of it, not less of it, as a result," said Simeon Willis, CIO at XPS.
"With the improvement in pension scheme funding levels, a very prominent concern for trustees is not going back to the deficit they used to have if market conditions reverse. Schemes that had a relatively low level of hedging have taken the opportunity to ramp that up significantly," and there are also cases where pension funds had zero hedging and now are at a high level, Willis added. "The upside to members is limited to the benefits they've been promised, but the downside of having a scheme with a deficit is if the sponsor goes insolvent, they lose some of their pension. We've ended up in a great place for pension scheme members, greater security of benefits, locking in, reducing allocation to equities, to diversified growth funds, increasing allocation to credits, doing more hedging: It's worked so well that everyone's looking at this fabulous pool of money and wondering how it can drive growth for the U.K. economy – which was never really its purpose. That's a tribute to how well it's done in what it's set out to do," he said.
Another improvement among many pension funds has been a push for a review of governance standards, sources said. With pension funds receiving multiple calls for increasing amounts of cash, some were found to be lacking when it came to having the governance structure in place to quickly make decisions. That's resulted in some trustees looking for more help from external parties, such as fiduciary managers, and others improving their operations more generally, with monitoring of positions on an ongoing basis an area of focus as well as improved collateral waterfall plans — which assets would be sold and in what order should cash be needed.