The Journey to LDI and Beyond

Abstract

The management of corporate pension plan assets has changed more in the past five years than in the previous three decades since the passage of the Employee Retirement Income Security Act (ERISA). It is probably not a huge stretch to say that in another five years, the core ethos and philosophy of plan asset management will bear little resemblance to how assets were generally managed over the ’70s, ’80s, ’90s, and the “aughts” before 2006. This article first addresses the nature of the regulatory and accounting changes responsible for the pension asset management paradigm shift, and then discusses the tools and frameworks associated with LDI. Specifically, the authors focus on: i) the value of reducing both asset allocations and liabilities to a common set of principal factors and what this means to constituent risks of the pension plan; ii) the recent rise in the implementation of glide path or dynamic de-risking strategies and the potential usefulness of risk factors to fine-tune glide path strategies for enhanced efficiency in risk reduction; iii) additional fine-tuning of glide paths through the use of derivatives; and finally, iv) some thoughts on the future as to what a largescale move may mean for some asset markets and how the LDI framework may evolve in the coming years.

TOPICS: Pension funds, fixed-income portfolio management, factor-based models