LDI Relatively Strong Performer in Downturn

February 2, 2009 (PLANSPONSOR.com) - Pension funds using liability-driven investment (LDI) strategies may not have been strongly in the black during 2008, but a new study suggested they tended to do much better than their non-LDI brethren.

According to a Watson Wyatt news release, portfolios using LDI strategies likely had returns in the negative single digits to break-even, while traditional asset allocation approaches likely yielded 20% to 30% losses or more.

A set of hypothetical portfolios — one LDI and one traditional — constructed by Watson Wyatt in December 2007 and tracked on a monthly basis demonstrates the sharp difference in returns.  For 2008, the hypothetical LDI portfolio broke even, while the traditional portfolio suffered a 25% giveback, according to the news release.

“New accounting and pension rules and the desire for more predictable returns have prompted some companies to adopt LDI strategies in recent years,” said Carl Hess, global head of investment consulting at Watson Wyatt, in the news release. “LDI served those companies well in 2008.”

Long Bonds

LDI’s emphasis on long-term bonds and liability hedges paid off handsomely last year — the long duration bond benchmark was up more than 8% in 2008, and interest rate swaps performed even better, with some returns of more than 30%.

But asset diversification worked less well.  That’s because most securities declined in value together. However, there was some value in diversification, as alternative asset classes generally did not have the same magnitude of declines and hedge funds continued to aid risk control.

“Although the liability hedge worked in 2008, last year’s high positive returns on swaps and long bonds will not likely continue going forward,” said Mark Ruloff, director of asset allocation at Watson Wyatt, in the announcement. “Despite this, the full range of liability hedging options has gained new credibility, and the recent financial turmoil has proved that its appropriate use has a definite value in controlling and managing risk.”

The report is available help .