Liability driven Investment (LDI) in action

Adjusting pension schemes’ investment strategies so that the assets move in tandem with the changing value of the liabilities (i.e., “matching”) is a natural approach for many schemes to adopt. “Liability Driven Investment”, or LDI, is increasingly commonplace. But does it really work in practice?

The chart below illustrates how the finances of one of our client’s pension schemes have been affected by the volatility in financial markets in the weeks following the UK’s referendum on membership of the European Union. Their strategy incorporates a significant degree of liability matching alongside a portfolio of growth assets.

Immediately after the referendum we saw a sharp fall in the yields on gilts and index-linked gilts. In general, this tended to increase the value of the liabilities of pension schemes because the future payments to beneficiaries must be “discounted” at a lower rate of interest.

In contrast, many assets typically held by pension schemes – most notably equities – fell in value. Many traditional bond portfolios did increase in value, but to a lesser degree than the liabilities because of differences in duration and because traditional bond portfolios normally only cover a portion of the liabilities.

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Pension Scheme Insight Report 2016

The Pension Scheme Insight Report 2016 is aimed at those responsible for designing pensions and employee benefits programmes in the workplace.

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