Pension funds have traditionally not shown much interest in liability-driven investing, or LDI. However, over the last five years in some areas of Europe, this has begun to change, spurred by a boom in the hedging of inflation and interest risk as pension funds become increasingly focused on risk management.
According to the 2011 KPMG LDI Survey, there has been a continued flow of pension assets into LDI solutions, with substantial increases in assets invested in both pooled and segregated LDI strategies over the last two years. The value of assets explicitly invested in LDI mandates has increased by 16%, from £210bn to £243bn, over the last two years. The total number of pension scheme mandates in the UK using LDI has increased from 584 to 624 over the same period.
In the survey report, KPMG Investment Advisory said it expects UK pension schemes will continue to move into LDI over the coming years, and another recent survey also agreed that LDI is becoming increasingly popular in the UK. The Future of Pension Funds 2011, a survey of almost 200 trustees with aggregate liabilities of at least £50bn carried out by Pension Corporation, noted that LDI is the most favoured de-risking strategy under consideration (56%) by pension funds at the moment.
The investment risk of a scheme’s portfolio will be incorporated into the Pension Protection Fund (PPF) risk-based levy for the first time in 2012, to reflect the differences in risk posed to the PPF by the investment strategies of eligible pension schemes. This will benefit those eligible schemes with liability-driven investments as they will be able to reflect the risk-reducing qualities of these investments in the bespoke stress test.
There has also been strong interest in LDI in Denmark, where many pension funds are run-out insurers, and LDI is also gaining in popularity in the Netherlands. Due to an uptake in demand for LDI solutions, AEGON recently introduced swaptions for some of its clients in the Netherlands as part of their programme. In the Netherlands, there is stringent regulation that, if a pension fund has not met its nominal liabilities, it has to have a much higher funding ratio. This is, therefore, a direct incentive to use LDI, especially to meet any inflation mismatch.
However, LDI is not universally popular in the Netherlands. Els Knoope, Managing Director, Strategic Portfolio Advice at APG, told PLANSPONSOR Europe that they are not currently doing much in terms of LDI with their pension funds. “We see our task as a pension investor so everything we do links to liabilities, but in terms of fully immunizing risk, we do not do much of this,” she says. “Many of our funds have fixed-income exposure but have chosen not to immunize the risk. Only a part of this risk has been hedged, as fully hedging would seriously detriment the opportunity to generate the return necessary to provide good and affordable pensions. Pension funds do have more options to protect the portfolio, such as selectively investing in real estate, commodities and infrastructure. There is still a lot of debate to be had on LDI.”
However, elsewhere in Europe, LDI has not been greeted with such open arms. Ophélie Gilbert, Head of LDI at Allianz Global Investors Investments Europe, adds that while LDI is becoming more popular in the UK and has seen some uptake from large company pension plans and public plans in France, in Germany—despite many discussions on the subject—LDI has, on the whole, been rejected.
In contrast, for insurers across Europe, LDI is a strategy that has been an integral part of their investment process, as by nature they have a lot of similar risks they needed to get off their books. This has also been tightening recently with more stringent regulation on capital in relation to liabilities ahead of Solvency II. Scheduled to come into effect on 1 January 2013, the new regulations will mean that insurers have to increase their capital provision if they take additional risk.