Metropolitan Asset Managers’ Hybrid and Structured Investment divisionis offering Liability Driven Investment product targeting defined benefit retirement fundswhich currently facingincreased market volatility.
MetAM is targeting small funds with assetsof up toR1bn, which makes up 90% of SA’s defined benefits.
While the localequity market has been favourable for defined benefit funds over the past four years moving many of these funds from an under-funded position, the persistent market volatility since the latter half of 2007 now puts many employers at riskas global markets move unpredictably. Investment strategies, however, have evolvedwith some asset managers now offering structured investment solutions to mitigate the risks specifically associated with a defined benefit fund.
Liability Driven Investments (LDI’s), while a popular long-term risk mitigation strategy used by defined benefit funds in the US and other markets,have rarelybeen employed by pension funds in SA to date.
LDI’s are essentially a form of investingin whichthe maingoal istoensuresufficient assetsare available to meetfund retirement obligationsat a predetermined dateupon retirement (in the case of defined benefit funds).
So how does a LDI work?
Once the fund managerrisk analyses a fund, appropriate assets are employed to matchthe duration of liabilities, and generate surplus absolute returns consistent with the appetite and ability of the fund to assume risk.
The asset manager wouldtypically devise and implement strategieson interest rates, inflationand equity performancein order to generate this surplus whilst at the same time ensuring that the obligations are met, even under simulated stress market conditions.
A liability driven investment is different as it replacesa typically irrelevant benchmark (such as an equity index) of a defined benefit fund with the true hurdle rate of the fund (the liabilities)
However, as asset managers do attach an additional cost for this active management, a good asset manager would regularly conduct stress tests on the model to ensure the fund can meet future liabilities under volatile circumstances.
This strategy has two main benefits.
LDI’s can be effective in locking in gains, replacing typically overweightequity exposure with an investment that ismore closely correlated to a fund’s future liabilities. In addition fundshave historically oftenunderestimated thelongevity of their members. With member living longer than expected andpost retirement obligations being larger,this effectively undervalues the liability obligation and may have serious implications for the share priceof the companyultimately responsible forthose obligations. A good LDI manager would be able to mitigate that risk.
Brandon Quinn (pictured above right), MetAM Portfolio manager [Liability Driven & Hybrid Investments]
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