This article is part of our on-going series on what strategies are being used by pension funds this year to address the risks of financial repression in their asset allocation and investment process.

LDI, or liability driven investment is a form of investing in which the main purpose is to gain a sufficient amount of assets to meet all liabilities, in the future and in the present; in other words, have enough money to pay for liabilities in the future. This strategy has been described to be the most prominent with pension plans, where assets and liabilities can reach in the billions of dollars on a larger scale.

The way pension fund investors do this is by closely tying assets to long term liabilities such as bonds, long and extended, intermediate bonds, and stocks. LDI is a highly used approach because the value of future pension payments are directly linked to inflation, interest rates and the longevity of pension plans . Bonds are mainly used because the volatility is low. To gather a proper solution, pension plans have to consider important factors while investing – one is managing liability risks and another is seeking appropriate investment returns. If they are successful at this, the fund level volatility will decrease over a period of time and assets will grow faster than liabilities. On solution for managing liability risk is hedge the liability risks by backing up investments with cash and very low risk bonds such as U.S. Treasury Bonds. For asset growth, pension planners aim for a specific growth, higher than the growth of their liabilities. , so they invest in stocks, corporate bonds, absolute return strategies, property and infrastructure. Pension fund managers only need to invest a certain about of assets into LDI, meaning they can diversity the rest of their assets to reduce risk. If both work effectively, assets will grow fast than liabilities and liability driven investment will be an effective strategy.

LINK HERE to a report by BNY Mellon

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.