The benefits of integrating bespoke LDI with CDI
In recent years, a growing number of pension schemes have adopted de-risking strategies that focus on generating more predictable returns and high-conviction cashflows. These strategies are often referred to as Cashflow Driven Investment (CDI), which integrates:
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Credit
Income-generating assets designed to achieve predictable returns above risk-free rates.
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Liability Driven Investments (LDI)
Manages interest rate, inflation, and future reinvestment risks.
We believe thoughtful and practical integration of credit and LDI is in schemes’ interests and separating the two is missing a trick.
What makes a successful CDI portfolio?
A well-organised LDI portfolio is essential for any pension scheme adopting a CDI strategy. As pension schemes de-risk, trustees and advisors should consider the following:
- Hedge precision: Ensuring precise hedging is crucial for delivering predictable outcomes.
- Optimal investment: Investments should maximise returns without excessive allocation to lower-returning LDI strategies. This requires a well-structured LDI portfolio to support an optimal allocation to income-generating assets.
- Risk management: The LDI strategy should manage rebalancing, redemption, and subscription requests without incurring out-of-market or operational risks.
- Costs: Evaluate the overall costs of different LDI structures in relation to their risk reduction and return potential.
Bespoke LDI… what advantages does it bring to CDI strategies?
A bespoke LDI portfolio within a CDI strategy offers significant benefits, particularly for smaller and medium-sized pension funds with assets over c.£150 million:
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Operational flexibility
Bespoke arrangements allow for intra-day hedging trades, targeted levels, and the ability to pause trades. This level of control is not available with multi-investor pooled funds. -
Smooth rebalancing
Bespoke LDI simplifies asset allocation rebalancing. Moving money out of pooled arrangements carries more risk due to the need for subsequent fund trades. -
Tailored capital calls
Bespoke portfolios can customise capital call timelines, ensuring efficient deployment of total assets. Pooled LDI funds, serving multiple investors, have strict capital call requirements. -
Precise hedging
A bespoke LDI portfolio provides a broad toolkit of instruments for precise cashflow matching. It allows tailored bond and swap holdings that meet specific cash flow and risk profiles, unlike pooled funds, which are generally less precise.
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Enhanced transparency
Bespoke LDI offers detailed daily reporting, enabling trustees and advisors to make informed decisions about their portfolios. This transparency is typically higher than what is available in pooled LDI funds
Should credit and LDI teams sit under the same roof?
Yes. Effective communication and coordination are key to a successful CDI strategy. By having credit and LDI teams working closely together, pension schemes can streamline processes and enhance risk management:
- Real-time insights: When credit strategies or asset holdings change, portfolio managers can quickly adjust the hedge profile. This was particularly valuable during the Gilt Crisis when rapid adjustments were necessary.
In short, bespoke LDI arrangements complement credit and enhance CDI strategies. With the cost of bespoke portfolios becoming more competitive, smaller schemes can now benefit from investment techniques that were historically only available to larger schemes.
