The number of pension schemes basing their investment strategy on the funds they will need to cover liabilities in the future has grown by six per cent between 2017 and 2018, research has shown.
using liability driven investment strategies grew by ,
Figures from retirement consultants XPS Pensions Group found that so-called liability-driven investment strategies together covered £1,024bn of liabilities in 2018.
A pension fund following an LDI strategy focuses on the assets in the pension fund with a view to covering the promises made to its members. This typically involves hedging.
In contrast, a benchmark-driven strategy is based on achieving better returns than an external index.
According to XPS the majority of these liabilities, 86 per cent, were hedged using gilt-based derivatives as most pension schemes are funded on a gilt-based measure.
Simeon Willis, chief investment officer at XPS, said: "We’ve known for some time that LDI, at its heart, protects a pension scheme from lower yield environments, which happens to be exactly the environment we find ourselves in today.
"LDI isn’t about making money, it’s about reducing risk and more schemes, of all sizes, are realising this and taking action.
"Following another strong year in 2018, we are expecting to see the focus of growth continue to shift towards pooled mandates, as more and more smaller schemes enter the LDI market."
Figures from XPS’s research align with a separate 2018 survey of industry trends conducted by Research in Finance, which found that 57 per cent of consultants believed their clients would increase allocations to LDI strategies in 2019, compared to just two per cent who thought these would reduce.
Research for RiF’s UK Institutional Market Study also found that 37 per cent of pension scheme managers were planning to increase allocations to LDI strategies.
Mr Willis said: "With DB pension scheme liabilities estimated to total approximately £1.9tn and over £1tn of these hedged using LDI strategies, it shows that trustees, advisers and fund managers are now firmly taking control of their scheme’s future and not leaving it to chance."
The XPS survey found that the majority of LDI liabilities hedged (87 per cent) were managed by three companies – Legal & General Investment Management, Insight and BlackRock.
Dean Wetton, founder of pension advisory group Dean Wetton Advisory, said while the appeal of LDI was clear, most schemes should not be hedged entirely.
He explained: "There is certainly a strong argument that you never want to be completely hedged, because that introduces a risk, in itself.
"The sweet spot is 75 per cent hedged because you are then benefiting from diversification. You are better off not being fully hedged, because going into a single asset class increases your risk, even though it is a matching asset."