Portfolio Insight – Legal & General Investment Management
Fundamentally, an increase in buyouts shows that we are doing a good job of being an LDI
manager. Emma Rayner, LGIM
Emma, how has the relationship with your LDI clients changed? Emma Rayner: A great deal. At the start, we were given narrow remits for interest rate and inflation hedging with a high degree of direction from our clients. Now we have more freedom to manage portfolios in the way we feel best. We are also acting as a strategic partner across whole portfo- lios rather than just for LDI.
switch, so again, moving early was beneficial.
What we have seen not work so well in the past were trigger-based strategies. Instead of pension schemes hedging at current levels, some schemes set levels above where the market was and would hedge if the market got there. We saw many schemes spend a lot of time designing complex trigger strategies against a back- drop of steadily falling interest rates. Most of those interest-rate triggers never hit, so despite the time they spent setting up an LDI strategy, they never did any hedging. Inflexible and illiquid strategies also did not work so well. We have learnt over the past 20 years that pension liabilities keep changing. This is due to regulation or membership changes, with people trans- ferring out of schemes.
This means that although pension scheme liabilities are 50 years plus in their nature, there is a lot of uncertainty in those long-dated cashflows. You need to design a hedging strategy that, while catching the long-dated nature of those liabilities, is liquid and flexible enough to adapt, at a low cost, as those changes come through.
20 | portfolio institutional | November 2021 | issue 108
Schemes are facing numerous challenges in a world that is only growing more com- plex; and they are increasingly looking to their LDI manager to help navigate it. Notwithstanding keeping pace with the huge volume of regulatory change that we’ve seen in our industry since LDI began, there are new and bigger problems they are asking us to solve for. Whether that is help with generating the cashflows needed to pay pensions or working out how a scheme can afford a partial or full insurance transaction; LDI managers are no longer just hedging interest and infla- tion risks but playing a larger role in ensuring a scheme can meet their obliga- tions to their members. There’s a perfect storm brewing, in that this increasing complexity is happening at the same time as schemes are becom- ing ever more governance constrained. We are seeing this play out across the industry in the form of consolidation and new types of delegation; for us, we see cli- ents increasingly recognising the value in having an LDI manager in place who can do so much more than just hedge risks. At LGIM, we have worked extremely hard to develop a holistic portfolio manage- ment offering which makes it easy for our clients to get what they need to do done.
What part has ESG played in LDI portfolios and how will this evolve? Pace: ESG has played an important role in LDI. That comes from the top of the organisation and permeates down. At LGIM, we believe ESG risk represents a material systemic risk for investors and we use our scale to influence investors,
governments, regulators, policymakers and companies. We embed ESG within our counterparty review process, where we assess credit- worthiness. We also engage with counter- parties via our investment stewardship team, analysts, portfolio managers and even the trading team. Governance and wider industry involve- ment is highly relevant to LDI. This sees us engage with the Treasury and associated parties on big topics around LIBOR, RPI reform and green gilts. Finally, ESG is crucial within our Sterling Liquidity Fund, which is an important part of LDI portfolio. These examples are far wider than just LDI portfolio manage- ment and it is important to have an organ- isation which is committed to that. Around evolution, green gilts are an obvi- ous area of development. £15bn plus of issuance this year and there is going to be more than £200bn worth of gilts issued in the next three to five years. As such we expect green gilts to become part of LDI portfolios, if the price is right. The final point is data and reporting, where LDI clients will be looking at ESG aspects in more detail. That could be how a counterparty scores on ESG or a newer
We have learnt over the past 20 years that pension liabilities keep
changing. Guy Whitby-Smith, LGIM
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