Scheme confidence drives LDI take-up

A report released by fiduciary manager SEI found 75 per cent of respondents had a planned or active LDI strategy. The proportion of schemes that were already using the approach had risen to 47 per cent, from 33 per cent in 2012.  

The recent increase in interest has been attributed to rising trustee confidence in the use of LDI.

“When it started LDI was seen as quite complex, so it took a while for companies and trustees to get comfortable,” said Simeon Willis, principal consultant at KPMG. 

Low UK government bond yields over the past few years are also seen as having slowed the rate of adoption, said Gavin Orpin, a partner at investment consultancy LCP.

“We’re seeing more mandates where [LDI strategies] are being viewed as a method for generating additional return as well as managing risk, but the real growth was pre Lehman Brothers,” he said. 

There is concern the use of LDI could stifle potential asset growth should gilt yields continue to grow. A continuation of this trend could cause interest rates to rise quicker than the markets expect, meaning funds using an liability-linked programme could lose out.

Willis said: “If we have a sluggish recovery [schemes] will be better protected, but if the economy does better schemes won’t do as well as they might have, had they not hedged.”

Outsourcing decisions

SEI's report also found an increase in the use of outsourced solutions such as fiduciary managers for “significant” decisions. Forty per cent of respondents assigned discretion to managers for hedging instruments and 26 per cent allow managers to decide the amount of hedging undertaken.

A number of consultants believe this increase is due to a combination of the growing complexity of LDI approaches and trustees becoming more comfortable with the idea of farming out decisions.

“Trustees are realising they have very little time to make the investment decisions they need to make, so delegation is starting to really take off,” said David Hickey, a director at SEI.

“With LDI employing more instruments you need someone to decide which to use,” said Orpin. “It makes sense to have a professional manager look at it on a daily basis simply because it’s grown in complexity.”

Schemes have been making use of evermore complex derivative structures. The report found synthetic gilts and alternatives were each used by 19 per cent of respondents, while options were used by 15 per cent.

“Because bond prices are very expensive, people are looking for other investments with a higher yield,” said KPMG's Willis.

Prior to the 2008 financial crisis, derivative strategies relied primarily on swaps, which were yielding more than gilts.

Orpin said now that gilt repos provide a higher yield, derivative strategies are being made up of a combination of gilt repos, total return swaps and interest rate swaps.