Liabilities as the new benchmark: outperforming what matters | Insight Investment

Can a liability benchmark offer a better measure of an LDI strategy's success than a traditional bond benchmark?

As defined benefit pension plans' funding ratios have improved, many have increased their allocations to fixed income. For many, the measure of success has evolved. For example, liability benchmarks have allowed clients to more directly align success to their investment outcome.

Defined benefit pension plans typically aim to generate excess returns against their liabilities in their LDI strategies. To achieve this, they typically invest in strategies benchmarked against traditional fixed income indices. But a bond index will not always directly relate to their pension liabilities, and outperforming bond index may not always mean outperforming their liabilities.

Many plans are considering a different solution: liability benchmarking. This instead treats their projected liability cash flows as the overall benchmark.

Doing this can open the door for fully customized approaches to LDI strategy design that we think can offer several clear benefits. For example, liability benchmarks can increase certainty and precision, and therefore help to reduce funded status volatility.

They can also avoid the duration drift that occurs between a fixed income index and liability durations that tend to roll down over time.

Liability benchmarks can also help avoid frictional costs of rebalancing to maintain target hedge ratios over the long term.

Furthermore, they can also allow clients to directly take into account complex benefit structures such as lump sum and cash balance benefit payments in their hedging strategy.

We believe liability benchmarking directly aligns a client's LDI strategy to their objectives and offers a more direct measure of managers' ability to deliver the alpha they require.

If you're interested in discussing liability benchmarking further, please contact us.