“There appears to be no end to growth” for liability driven investing (LDI), in the UK, according to a recent survey from auditing and accounting firm KPMG. More than 1,800 pension plans now use LDI as a part of their investment strategy, an increase of 27% over last year. There was also £908 billion of exposure to LDI from UK pension plans at year-end, up from £739 billion at the end of 2015.
“The growth in the market in percentage terms has been consistent and relentless,” said Simeon Willis, KPMG’s head of investment strategy. “With this growth has come a change in mind-set. For many the question now is ‘when should we be fully hedged,’ not ‘if.”
However, Willis adds that being fully hedged “presents some new challenges,” because failing to match the hedge to the liabilities can increase the deficit or even create a new deficit after full funding has been achieved.
“This presents a new level of challenge for consultants and providers as well as actuaries to make sure their liability valuation methods are as reliable and accurate as the market values of the matching assets held,” he said.
Because pension fund liabilities are closely linked to inflation, UK pension funds seeking
assets that are sensitive to inflation usually purchase index-linked gilts, which are bonds issued by the British government. Despite the fact that index-linked gilt yields are “falling to their lowest point this century,” according to KPMG, a growing number of pension plans are using LDI as a risk management tool.
“Over the last five years, liabilities will have typically grown by 30% to 40%,” said Willis, “meaning assets will have needed to outperform to stand still on the value of the deficit, despite being fully hedged.”
The survey also found that:
- Pooled LDI accounts for almost all the growth in the number of LDI mandates from 2016, and there are now more than 1,200 pooled LDI mandates, an increase of 42% from 2016, and an average size of £100 million of liabilities hedged.
- Almost all LDI managers surveyed identified regulation as the most important issue facing the LDI industry in 2017. Approximately 44% of managers said the central clearing of derivatives was the most important issue facing the LDI industry, while another 38% cited other regulatory/legislative changes.
- 80% of LDI managers surveyed expect growth in liabilities hedged to come from new business. This demonstrates that the growth in the LDI market is not expected to stall, says KPMG.
- LGIM, Insight, and BlackRock continue to be the largest managers within segregated LDI; the same managers, along with BMO and Schroders, are the largest providers within pooled LDI. BMO in particular managed to win the largest number of new mandates over 2016 with more than 100 new plans.