Portfolio Insight – BlackRock
Pension funds have benefited from LDI during the past two decades.
structure. This could be a LDI portfolio supported by cash and something like a short-duration corporate bond or an as- set-backed security fund that has daily li- quidity. It gives you a bit of return when you don’t need it for collateral, but if you do, you can sell the assets to get cash quickly. I suspect professional trustees are seeing an increase in interest also.
Is there anything around LDI that should be questioned based on the events of last year? Pension funds have benefited from LDI during the past two decades. It enabled them to meet their dual objectives of managing their biggest risks at the same time as being able to invest in return- seeking assets that are expected to reduce their funding shortfalls.
Over the long-term, it has been a benefit, but it needs to evolve. As I mentioned, this is along the lines of more collateral, less leverage, more access to other assets and a stronger overarching governance framework, so if there are issues when ac- tion needs to be taken quickly, then that can be done.
In this new landscape, DB pension scheme trustees face many tests on many fronts. What are the priority challenges they face? One comes at this from what we have been discussing: funding levels have im-
30 | portfolio institutional | June 2023 | Issue 124
proved. There are new funding and in- vestment regulations and the code of practice. At the forefront is the ability to pay contributions to the scheme as and when needed. We would have thought that with the changes last year it would be time for an investment strategy review for most pen- sion schemes. Our experience is that they are doing this now – with their consult- ants, their internal teams and with their asset managers.
They may find their asset allocation mix has changed compared with last year. The denominator effect, whereby your LDI portfolio has grown, your liquid risk as- sets have shrunk, but you have propor- tionally quite a lot of alternatives and more illiquid assets than maybe you would want according to your asset alloca-
tion, perhaps needs to be reviewed in light of your new funding position. What we are seeing, and it is no surprise, is a big appetite for LDI and liquid fixed in- come. This could be used in that collater- al waterfall structure. They are better funded, so need less return and fewer higher return-seeking assets, such as equities.
They can get a lot of what they need from a combination of LDI and fixed income. Government bonds, for example, in short duration, yield 3.5%. Add a bit of invest- ment-grade credit spread on top of that and you are getting up to 5%, which is a considerably higher yield than from short dated credit around a year ago. You can now do a lot with credit that you couldn’t have done in years gone by.
What endgames are DB schemes opting for? The bulk of pension schemes are still at some stage looking for an annuity buyout, thus transferring their assets and liabili- ties to an insurer. They have their own re- source and many of them are looking to run off their liabilities themselves. There are new entrants looking to come into the market, such as superfunds which have been around a while. So that is a possibil- ity. The assets and liabilities would be transferred from the pension scheme to a superfund which would run them for five to seven years before transferring them to an insurer for an annuity buyout.
You can now do a lot with credit that you couldn’t have done in years gone by.
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56
