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Potentially though, LDI can be much more closely integrated with the non-gilt assets in a CDI strategy when compared with a traditional strategy to create a fully robust solution. This is because, although LDI hedging can still be expressed in interest rate risk terms, the LDI structuring for a CDI strategy can also be analysed at the granular level of the more certain annual cashflows from the non-gilt assets. Effectively, in cashflow terms, LDI hedges the reinvestment into gilts of the excess cash scheduled to be received from CDI strategies in one year used to pay benefits in later years.
Summary and conclusions We have presented our discussion in this article in binary terms to make our argument whereas in reality of course the difference between asset classes is more nuanced: high yield credit is more like equities than investment grade credit and more highly rated investment grade credit behaves more like gilts than lower-rated credit. However, we believe that our broad conclusions remain even in the more complex real world.
Our key observation is that closely matching the asset inflow from non-gilts to the liabilities is not neces- sary in a CDI strategy once it is accepted that the gilts can “fill the gaps” in cashflow matching solutions. Instead, if LDI is used to match liability outgo, the important difference between traditional strategies and CDI strategies is actually the greater certainty of asset inflows in CDI.
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March 2019 portfolio institutional roundtable: CDI 25
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