Portfolio Insight – Legal & General Investment Management


area around what the carbon footprint of a gilt or derivative actually looks like. Those are of some of the key things for the future.


What does an LDI portfolio in the future look like? Whitby-Smith: It will be less focused on the pure LDI aspects and be more of a match- ing portfolio, designed to meet a scheme’s cashflow needs along with a portfolio that meets the interest rate and inflation risk aspects of a pension scheme’s liabilities. It will be designed with cashflows in mind to make sure it can meet a scheme’s short and long-term liquidity requirements. To do that, the LDI portfolio needs to be managed alongside the credit in the port- folio – public, private and real assets – in a holistic manner.


A future LDI portfolio will also have a sin- gle pot of collateral to support all the derivative transactions the scheme under- takes. The advantages of this structure in- clude minimising collateral drag because you only need one collateral pot reducing the allocation to lower yielding assets to meet the collateral requirements of the scheme.


It also protects against volatile markets. We have seen the return of volatility in the past 18 months, which we expect to con- tinue. To minimise the risk of a scheme becoming a forced seller due to the lever- age in its portfolio, a single pot of collater- al is more likely to be able to withstand whatever market moves come your way. Other considerations that will come into play for well-funded, well-hedged schemes include the second and third order effects that you did not worry about at the beginning of your LDI journey, but at this stage will start to dominate. One of those is inflation. It is currently high, but it has been high and volatile across longer maturities as well. This has a profound impact on the make-up of pension scheme liabilities. To manage those liabilities accurately you need to frequently refresh your assump-


For professional clients only


We expect green gilts to become part of LDI portfolios, if


the price is right. Robert Pace, LGIM


scale and our relationships with counter- parties in stressed markets. In March 2020, for example, our trading volumes were up 30% on the same month a year before as we reacted to rapidly changing market conditions to support our clients through that crisis. As LDI markets mature, we will see an increasing difference in the ability of funds to operate at scale and with that a willingness by managers to enhance their LDI capabilities.


tions regularly. If not, schemes could find that the hedging is not performing and behaving as intended. We have an approach for the well-hedged schemes called dynamic inflation hedg- ing, which adapts to market conditions, so it remains appropriate in all markets.


What does the ever-increasing trend to buyout mean for LDI providers? Rayner: In the past 20 years various LDI players have come and gone and what has become clear is that scale is important. It helps keep costs low, not just for clients, but for providers as LDI is a low margin business.


Scale also matters when times are tough. We have a strong record of leveraging our


Over 50% of LGIM’s assets are currently managed by their Solutions team and Legal & General, the insurance parent, wants to transact between £40bn to £50bn of new annuity business over the next five years. We are well positioned not only to retain our scale but also for growth, which means we will continue to invest and innovate in this area. Because of our insurance parent, we are the only LDI manager who can be truly objective in helping clients reach their endgame, whether that be self-sufficiency or a buyout. Whilst the trend towards buyout might be seen as a threat by other LDI providers, for us, it is a welcomed opportunity. Fun- damentally, an increase in buyouts shows that we are doing a good job of being an LDI manager. And as so many of our cli- ents chose to transact with Legal & General, you will hopefully see us being in the business of liability investment for a long time to come.


Issue 108 | November 2021 | portfolio institutional | 21


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