Dynamic Liability-Driven Investing Strategies: The Emergence of a New Investment Paradigm for Pension Funds?

Saad Badaoui, Romain Deguest, Lionel Martellini, Vincent Milhau: In the present publication, which was produced as part of the BNP Paribas Investment Partners research chair at EDHEC-Risk Institute on “ALM and Institutional Investment Management,” led by Professor Lionel Martellini, we have attempted to assess the views of pension funds and sponsor companies as they relate to their reactions to dynamic liability-driven investing (LDI) strategies and their desire to integrate this approach into their processes.

Author(s):

Saad Badaou

Senior Quantitative Analyst at EDHEC-Risk Institute.

Romain Deguest

Senior research engineer at EDHEC-Risk Institute.

Lionel Martellini

Professor of finance at EDHEC Business School andscientific director of EDHEC-Risk Institute.

Vincent Milhau

Deputy scientific director of EDHEC-Risk Institute.

Our conclusion is that progress remains to be made in the area of appropriate risk management for pension funds. As such, the survey finds that LDI is popular, but in concrete terms the fund separation approach, which is consistent with the LDI paradigm, is not yet sufficiently widely applied to manage the LDI approach optimally, especially in southern European countries. In the same way, one of the key points in LDI for pension funds is hedging with respect to the duration of the liabilities, but it is not always implemented by pension funds, even though they affirm that they use LDI-type solutions. The risk allocation approach is gaining ground, not only because it questions the active management offerings in favour of passive investment, which has come up with innovative offerings in the area of factor investing in recent years, but also because it contributes to a better understanding of  institutional investors’ risks and diversification. From that perspective, we can see an acceleration in the adoption by professionals of concepts that are well documented in the academic world. Ultimately, too many pension funds are still more concerned with standalone performance than risk management, which explains why they favour tactical allocation or reviews of strategic allocation over risk management in ALM. On this subject, we observe a clear difference in the rates of adoption of dynamic LDI between the north and the south of Europe. In the end, too many pension funds remain asset-only rather than ALM funds and do not take sufficient account of the impact of their liabilities in their asset allocation policy or risk management.

Type: EDHEC Publication
Date: le 03/02/2014
Research Cluster : Finance

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