From the blog: Liability-driven investment has experienced explosive growth among pension schemes.
A small number of big firms dominate, with 85 per cent of liabilities hedged being managed by just three companies.
But this is in sharp contrast to the pension scheme tradition of diversification between asset classes, regions and active managers.
A small number of big firms dominate, with 85 per cent of liabilities hedged being managed by just three companies.
Almost all UK pension schemes have a single LDI manager with the exception of the PPF, which has a panel of four.
But this is in sharp contrast to the pension scheme tradition of diversification between asset classes, regions and active managers.
There can be a significant risk involved in putting all your LDI eggs in one basket.
The lack of a suitable readily available alternative can cause a significant issue in the unlikely but high-impact event that there is an operational or service problem with the incumbent LDI manager
In the past, the infrastructure needed and risk profile for LDI have been viewed as similar to those for passive management, where a single manager has typically been viewed as sufficient.
However, while LDI management has some similarities to passive it also has distinct differences.
LDI managers often generate trade ideas, which increase the dependence on manager judgment and skill, as with active management.
In addition, replacing an LDI manager is much more complicated than for a typical passive mandate, because it includes moving derivative contracts that are more complex to buy and sell than physical securities.
Crisis planning
This complexity and the lack of a suitable readily available alternative can cause a significant issue in the unlikely but high-impact event that there is an operational or service problem with the incumbent LDI manager.
So having an alternative LDI manager on the bench provides a neat alternative to finding a replacement in an emergency situation.
It means hedging can continue uninterrupted, limiting both the opportunity cost and the overall risk.
The benefits go beyond contingency planning. Having a second LDI manager should encourage competitive pricing throughout the life of the mandate.
It could be that some of the challenges involved in having two LDI managers have been seen as barriers in the past.
Schemes would need to carefully manage the potential costs involved, as well as ensure there is no overlap between the hedging mandates of both managers.
The infrastructure must be in place for both managers to have full data and up-to-date reporting at hand.
Lucy Barron is a solutions strategist of UK LDI at Axa Investment Managers
