After studying the issues, we helped my client to the conclusion that better alignments between pension investments and liabilities were warranted. This liability-driven investing (LDI) is a growing area of interest for defined benefit plans. But like most growth areas, the theory has been easier than the practice.
The theory is pretty simple. LDI usually involves buying longer-duration bonds (long bonds). The goal is to align long-dated pension obligations to long-dated investments. When the liabilities and assets are better matched, the funded status of a plan stays more stable. As a result, accounting expense and cash requirements tend to be less volatile. (For more on LDI, see here.)
Until recently, a major obstacle to LDI has been finding low-cost products for plans with under $100 million in assets. Consultants could tell you what LDI was in theory, but actually doing it? There were no standard products. Each pension plan needed an individually designed LDI program and specialized consulting. That can be an expensive proposition for smaller plans.
In the past few years, investment companies have started to roll out more long bond mutual funds and standardized LDI products. This is a significant step forward for smaller pension plans looking to implement LDI.
But not all LDI products are equal, of course. Before selecting a product, it's worth performing some due diligence with your investment advisor. It can also help to consult your actuary.
My client found a relatively new LDI product and graciously invited me to kick the tires. Overall, I offered my opinion that the product seemed like a good fit for this pension plan.
With one caveat.
In a follow-up blog post, I'll discuss the new LDI product, and a concern I raised about its design.