What does the future hold for LDI?

Alan Gander: It has still got a way to run yet. I think it will still get sold; next year people will still be buying into it. I just think it will become better sold, more explainable.

Howard  Kearns: This is happening at a time when fixed income markets are becoming more difficult, more complex. Banks are less willing to do very long-dated swaps. There is more regulation. There is less liquidity in some elements of the fixed income market.

Mike Roberts: Is that a real tangible squeeze on the LDI providers?

Kearns: I do not think it has had a significant impact so far in terms of being able to trade. But there is more regulation coming which then leads to more complexity – for example, in the way swaps are valued.

Roberts: The providers just have to deal with that and not pass the problem of the additional costs onto the schemes.

Kearns: True, that is our problem and the adviser’s problem, rather than trustee’s problem.

Gander: So what will end it? That is what I am interested in. When will you look at LDI and say, ‘No, that is not what we need to do.’ What would have to happen?

Kearns: It becomes more what you need to do as schemes run off. So as you move through time there will be more of a push towards LDI, rather than away from it. 

It is not massively levered now, but there might be less use of leverage as schemes become better funded and therefore don’t need to use leverage so that they can invest in growth assets. I can see that evolution slowly coming through, but less use of LDI I cannot see.

If you want to insure a whole scheme and you have got pensioners and deferreds, then the cost will be prohibitive in most situations

Howard Kearns, SSGA

Mark Versey: The scope of LDI is going to grow. We are seeing people who implemented LDI a long time ago; it has been really successful. And as the schemes are becoming more mature, they are asking, ‘How do we add risk to our LDI portfolio?.'

Roberts: This evolution is definitely what I would see in some of the schemes I deal with, where they are now quite heavily focused on buyout as a funding objective, or possibly a secondary funding objective. And I think that is where the LDI market will go.

It is like, ‘Okay, how does this morph into something that is more buyout-focused and how does a scheme make that decision?’ I do not know whether your trustees or your sponsor have said, ‘We want to buy these liabilities out or we want to run the liabilities off,' or they have not yet contemplated it.

Gander: I do not think we are considering buy-in or buyouts at the moment. We did buy into LDI a bit prior to me becoming a trustee, but then subsequently sold it for a profit.

Versey: That makes sense as you would have hedged interest rates, then interest rates would have fallen, which would have made the hedge money. You have then taken your hedge off, thinking interest rates are not going any lower.  

I have seen the same thing myself where an early LDI hedge had been taken off, with huge regret risk looking back, obviously.

Gander: But from a trustee’s point of view, buy-in and buyout, that is where I want to go because defined benefit schemes are now shut or shutting and the ultimate goal for sponsors is to offload their responsibility.

Roberts: It is not like you have buy-in or buyout next year, but if you are going to ultimately want to do that, then how do we get the investment strategy – including the LDI portfolio – to align with it? Because at the moment, I do not think LDI is directly consistent with that.

Laura Brown: The future of LDI is definitely evolving towards thinking, what is the ultimate objective? It is paying the pensions. Therefore, do we want to do that by running the scheme ourselves or through involving an insurance company? How do we evolve the LDI bit alongside the other matching assets to enable us to do that?

Roberts: I would suggest that, knowing how most trustees and most sponsors think, both would prefer to buy out liabilities if they were in a position to do so. They would not run the scheme off because there is continuing cost and time to operate the scheme.

As the number of pensioners reduces, do they still want to be running a pension trust and paying pensions out? Probably not.

Gander: I think most sponsors just want to buy out.

Celene Lee: I find it quite interesting that for some schemes, when you ask the client, ‘do you ultimately want to buy out?’ it would be a resounding yes. I have seen a scheme with a very strong covenant and was able to just pay a premium in to buy out.

But at the end, when it comes to really writing the cheque, they just sort of back off and the scheme will then have to run on as a closed scheme, [on an] ongoing basis, but with a fairly low risk portfolio.

Versey: It can be quite a premium to pay for a buyout, compared with where a scheme could be self-sufficient.

Kearns: If you want to insure a whole scheme and you have got pensioners and deferreds, then the cost will be prohibitive in most situations; buying in pensioners has become relatively more affordable.

It sounds like we are all in quite violent agreement about the future: ‘LDI is not a set-and-forget strategy.’

Laura Brown, LGIM

Roberts: I think it is when the scheme is of a maturity level that most of the liability is pensioners. That is when most schemes would then buy out. A lot of schemes are not too far away from that situation.

Brown: Buying in chunks of pensioners over time is a popular strategy.

Gander: It is the way people think, isn’t it? To pay out more now does not seem right to the human being, does it? It is a bit like when someone says, ‘Would you like to contribute to this, or buy into this magazine? You can become a life member.’ Or, ‘Join the National Trust. You can become a life member. £1,000 now, or you can pay £60 a year.’

Lee: The way I see this, LDI plays a role, which is one of the roles that you can have within a matching or low-risk portfolio, but I think inevitably the right thing to do is not to invest all your matching portfolio into LDI and just forget it.

Brown: It sounds like we are all in quite violent agreement about the future: ‘LDI is not a set-and-forget strategy.’

This roundtable was chaired by Pensions Expert reporter Tom Dines