Report Says LDI to Become Standard Practice for DB Plans

In its report, Russell suggests LDI – an approach to pension fund investing that structures asset portfolios so they behave more like pension liabilities – could become the foundation for the investment strategies of a majority of pension plans in the United States within the next five years.

“The momentum for LDI has been building over time, has been given fuel by the events of 2008, and will be further accelerated by accounting changes due within the next five years,” said Bob Collie, director of investment strategy at Russell and author of the Russell Retirement Report 2009, in a press release.  “Trillions of dollars will be impacted as attitudes shift, familiarity increases and the herd mentality begins to favor, rather than resist, change.”

In the 2009 retirement report, Russell outlines how the market events of the last few months will lead to an increased focus on LDI and to changes in the way in which LDI programs are built.  The focus of programs will move beyond interest rate risk to incorporate other factors, including credit risk, yield curve risk and timing.  In time, the nature of LDI will change again as risk transfer solutions become more widespread.

According to the report, the management of interest rate risk can be grouped into four basic stages. The first stage is to lengthen the duration of the existing fixed income assets, followed by reallocating riskier assets to fixed income. The third stage is the overlay stage, using swaps or other derivative instruments to match the liability return behavior, and finally, the immunize stage is where more precise steps are taken to lock asset behavior in to liability behavior. Russell says that ultimately, these solutions move beyond investment and into the realm of risk transfer.

In addition, Russell contends the impact that pension plans have on their sponsoring corporations has in some cases become too big to ignore. The report uses an illustration comparing airlines and oil companies. “On the surface, the pension plans of the airlines do not look very different from those of the oil sector. But by testing the potential impact of those plans on the corporations themselves, a very different picture emerges,” the report says. According to Russell, the analysis provides important context for understanding LDI for any type of company.

The report discusses in detail the state-of-the-art in Liability-Driven Investing and closely examines the consequences of the market events of 2008 on this investment approach.

It is available at http://www.russell.com/rr2009 .