Customizing an LDI strategy
We believe in designing an LDI strategy by understanding the sponsor’s risk appetite and utilizing hedging instruments effectively. While doing so, we also maintain an exposure to growth assets to either recover a deficit in funded status and/or grow assets to align them with active members’ service costs. More generally, we feel that an LDI strategy may incorporate growth assets as a buffer to offset intrinsic risks that are unhedgeable.
Initially, the LDI team partnered with the client and the client’s investment consultant to understand the client’s objectives and goals. As part of the discussion, the LDI team offered general LDI education, which included how derivatives can be carefully used to help reduce risk in a pension plan. The client objectives and goals are outlined as follows:
Reduce risk and lock-in funded status gains by purchasing physical securities
Hedge portfolio: As the funded status improves, the hedge portfolio allocation will evolve from using a market benchmark (e.g. Barclays Long Gov/Credit) to one that is far more customized in nature (e.g. term to maturity sleeves of the Barclays Long Credit benchmark index).
Growth portfolio: Strategic asset allocation with the growth portfolio to be defined by investment consultant
After understanding the client’s goals, the team carried out risk modeling and analytic work for the plan. This included a holistic portfolio-level asset-liability modeling analysis to understand the plan’s asset risk relative to liabilities and in terms of risk budget and funded status. The charts below illustrate in more detail the asset-liability risk analytics conducted.
The data/charts/graphs throughout this presentation are for illustrative and discussion purposes only. Source: J.P. Morgan Asset Management Inc.
Derivatives may be riskier than other types of investments because they may be more sensitive to changes in economic and market conditions than other types of investments and could result in losses that significantly exceed an original investment. Many derivatives will give rise to a form of leverage. Derivatives are also subject to the risk that changes in the value of a derivative may not correlate perfectly with the underlying asset, rate or index. The use of derivatives for hedging or risk management purposes or to increase income or gain may not be successful, resulting in losses.