What Is Liability-Driven Investing?

Liability-driven investing, or LDI is an investment strategy that focuses on matching assets with current and future liabilities. The approach is used by companies with pension plans to help ensure that liabilities—which consist of current payments to retirees and future payments promised to employees upon their retirement—can be funded by the plan’s assets.

How does LDI differ from a traditional investing strategy?

The funded status of a corporate pension—or defined-benefit (DB)—plan is calculated by subtracting the plan’s liabilities from its assets. Traditional investment strategies for DB plans focus on generating a specific rate of return for the plan’s assets. This rate of return is typically based on a benchmark from a broad-based equity index, such as the S&P 500® Index—with a goal of generating returns in excess of the benchmark.

Liability-driven investing, by contrast, focuses on aligning the plan’s assets with the projected benefit obligations, or liabilities, due to plan participants. There is typically a mismatch between assets and liabilities in defined-benefit plans, due in large part to the impact of interest-rate changes on both. In a standard pension plan, liabilities are typically far more sensitive to rate fluctuations than assets are. This causes a plan’s liabilities to grow or shrink at a much greater rate than its assets as interest rates change. Liability-driven investing aims to eliminate the difference between the two, matching assets with liabilities in order to better manage the plan’s risk of not meeting obligations to employees and pensioners.

A plan’s projected liabilities over a certain length of time—such as 10 years—are usually calculated by an outsourced chief investment officer (OCIO) provider, asset management firm, investment consultant or actuarial firm, as part of a comprehensive study of the plan’s assets and liabilities. Investment policy and asset allocation decisions are then typically made with the overarching goal of meeting these liabilities.

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Disclosure: These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

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