Liability-driven investing (LDI) at Mercer

LDI helps stabilise a scheme’s funding level and protect members and sponsoring employers from unintended volatility stemming from interest rate and inflation changes. This is accomplished when trustees decide to invest a portion of scheme assets in carefully chosen assets (typically Gilts and Gilt-based instruments) so the assets move in-line with liabilities when interest rates and inflation change. 

With DB pension schemes increasingly mature, well-funded and cashflow negative, LDI has increasingly become a central pillar of pension scheme funding strategy as schemes approach their later stages whether that be run-on, surplus generation, risk transfer or some combination of these alternatives. With this in mind, getting LDI “right” is crucial.

We are solutions-oriented and offer LDI in two ways: 

The choice between the two approaches will reflect the investor’s individual circumstances, objectives and ultimately what represents best value to the end investor. Whilst not an exact science we typically focus on bespoke LDI solutions for schemes with greater than £100 million of assets and pooled LDI for smaller schemes.

In all cases, liability matching portfolios are tailored to a scheme’s liability characteristics as reflected in a scheme-specific Liability Benchmark Portfolio (“LBP”) which we carefully and accurately construct at the outset and monitor and update over time.

Where a bespoke LDI mandate is used, that portfolio can be highly tailored to the scheme’s requirements with access to the full market opportunity set with bespoke derivatives tailored to the scheme’s precise liabilities and objectives. Collateral will be managed via a single centralised pot, offering a range of opportunities to integrate the mandate with wider scheme assets (in many cases supporting derivatives more widely across equity and credit markets) and setting tailored collateral buffers/top up mechanisms.

We have seen multiple cases of schemes moving from pooled LDI to Bespoke LDI, reflecting a higher Trustee focus on LDI implementation and recognition of the additional tailoring and reporting benefits Bespoke LDI implementation can bring.

Through multi-investor pooled LDI funds Schemes benefit from being able to blend a range of c.20 multi-investor pooled funds (comprising a wide range of fixed interest, index-linked, leveraged LDI and corporate bond funds), to carefully match the sensitivities of the scheme’s LBP. Under this approach, we establish a delegated collateral management framework giving trustees comfort that in the event of Gilt market volatility, collateral can be moved from one fund to another (“re-collateralisation”) robustly and efficiently without requiring further instruction.

Our LDI clients and their advisers receive a bespoke reporting suite which includes key liability hedging metrics, including the hedge profile vs. its liability benchmark and levels of collateral resilience. Additional “drill down” detail on individual holdings and counterparties is available where required. Clients and their advisers have the same information available to our LDI portfolio managers.

The experience of 2022 focussed many trustees’ attention upon the shortcomings of LDI collateral management frameworks. Since 2022 we have played a significant part in the evolution of the “new normal” working with key industry stakeholder such as the Pensions Regulator and the Bank of England to ensure updated regulation appropriately balances risk management alongside practical implementation of LDI. 

• Within our Bespoke LDI mandates, beyond increased collateral buffers and greater focus on collateral waterfall strategies, we have seen Schemes integrate corporate bonds within their LDI programmes. Integrating LDI together with corporate bond holdings allows greater hedging accuracy and enhances flexibility to support the collateral requirements of the LDI portfolio. 
• Within our Multi-investor pooled LDI funds, we have materially increased collateral buffers (with all funds targeting levels of collateral resilient to a 4% rise in Gilt yields) and the speed with which collateral can be moved from one fund to another (cash settled within 5 working days), to ensure that pooled LDI is delivered to our clients in the most robust and efficient fashion possible.

While we think the enhancements made since 2022 are material, we continue to seek further innovative ways to manage and implement LDI robustly and seamlessly on behalf of investors.

We have deep experience of transitioning LDI mandates, whether that be from pooled to pooled, pooled to Bespoke or Bespoke to Bespoke, with our specialist transition team taking care of the heavy lifting on behalf of investors. While mandate specifics matter, in the vast majority of cases LDI mandates are able to be transitioned with low or zero costs.

With over £10 billion of assets under management in multi-investor Pooled LDI funds, we are well positioned to deliver economies of scale to smaller schemes, delivering competitive cost levels and value for money to investors.

Historically, Bespoke LDI has been seen as either too costly or complex for small to mid-sized schemes. That’s no longer the case with Bespoke LDI increasingly accessible to schemes with total assets as low as £100 million, often costing no more than multi-investor pooled LDI funds through other providers.

We get it. LDI implementation is highly technical. Whether implementation is through Bespoke LDI or Multi-investor pooled LDI funds, the benefits of Mercer’s LDI implementation must exceed costs – and the transition must be safe and efficient.

If you share a small amount of information about your current LDI arrangements e.g. size of hedge and current investment structure, we’ll offer you our proposed LDI solution, an LDI fee and an indicative transition plan to help weigh the pros and cons.