Watch Out for Liability Driven Investment Strategies

2022 Oct 24Pension Litigation

Check your defined benefit pension plan to see if your investment manager deploys Liability Driven Investment strategies (“LDI”) in your company’s pension plan. If so, we strongly suggest you contact this firm, or another law firm that handles ERISA litigation, for a due diligence review on your investment portfolio.This is because in a volatile economy (such as we are entering in 2023), LDIs can under-perform, because of liquidity constraints they may pose to the Plan.

A “Liability Driven Investment” strategy involves debt instruments of different maturity dates.  (See FAQ) The idea is to match maturity dates with payments to plan participants. Conceptually, this is a logical approach to fund management.

But the very important question to ask about LDI is what kind of debt instruments is the fund invested in?

Are the debt instruments publicly-traded–and therefore have a transparent market value on a daily basis?

Or are the debt instruments in the fund derivative complex products, such as structured notes, whose current value is not readily apparent?

And are there interval restrictions on withdrawals, or can the debt instruments be readily transferred to cash?

Almost everyone is aware by now that the UK pension system very nearly imploded on Oct. 16, 2022, which caused its new prime minister, Liz Truss, to resign after only 44 days in office. What is not well known is that a Liability Driven Investment strategy was apparently at the center of the pension system’s near-meltdown.

The fund needed access to cash that was not readily available because of the liability driven investment strategy used by fund managers.  Specifically, debt instruments in the fund were apparently designed with opaque valuation problems and/or had withdrawal limitations that prevented converting the fund’s debt assets to cash.  Hence, the liquidity problem that very nearly caused the entire UK pension system to implode.

Are LDI strategies used in the US for defined benefit pension plans? Yes, and widely so.

The Largest U.S. funds using LDI strategies are as follows:
Plan sponsor Total U.S.
DB assets
LDI assets
(in millions)
Raytheon Technologies $55,029 $23,065
United Parcel Service $52,952 $20,922
General Electric $61,316 $20,357
Kaiser Foundation Health Plan $65,479 $16,605
Caterpillar $17,087 $12,252
MetLife $10,365 $8,328
Prudential Financial $14,499 $7,833
Honeywell International $21,793 $7,803
Exelon $20,764 $7,234
Corteva $17,224 $7,103
Merck & Co. $12,718 $4,790
National Technology and Engineering Solutions of Sandia $6,979 $4,662
Bayer $5,796 $4,152
American Airlines $14,308 $3,963
Deloitte $8,535 $3,940
Farmers Group $3,899 $3,249
Morgan Stanley $3,102 $3,102
Target $4,583 $2,254
Ameren $5,751 $2,135
Michelin North America $3,093 $2,100
ViacomCBS $3,208 $2,024
Eastman Kodak $3,959 $1,875
MUFG Americas $5,062 $1,832
Lockheed Martin $36,167 $1,751
Thomson Reuters $2,388 $1,594

If you have a pension investments in one of these funds, we recommend you seek a portfolio review from us, or from another firm that does ERISA litigation.  Initial consultations are performed without charge by us, and by many other firms.  Don’t let your pension investment implode because of a leveraged derivative investment.

FAQ

Liability Driven Investment (“LDI”) Explained

What is a Liability Driven Investment Strategy for a Defined Benefit Pension Plan?

A “Liability Driven Investment” strategy for a DB pension plan involves debt instruments of different maturity dates, such as a bond that mature in, say, 2003; and a different bond that matures in, say, 2004, and so on. The idea is to match maturity dates with payments to plan participants. Conceptually, this is a logical approach to fund management.

Are Liability Driven Investment Strategies a Good Idea in a Pension Plan?

In a stable or growing economy, Liability Driven Investment strategies are immenently sensible, since maturities of various liability instruments (say, bonds) can be matched to retirement dates of plan participants.

But in a volatile or shrinking economy, an additional question must be asked: what kind of liability (debt) instruments is the fund invested in?

Are the debt instruments publicly-traded–and therefore have a transparent fair market value value on a daily basis?

Or are the debt instruments in the fund derivative complex products, such as structured notes, whose current value is not readily apparent? (See discussion, here.)

And are there interval restrictions on withdrawals, or can the debt instruments be readily transferred to cash?

Is LDi Likely to be a Bad Investing Strategy in a Volatile Economy?

An LDI strategy is may be a bad investing strategy in a volatile economy if the pension plan holds alternative pension investments. Here’s why: If a pension fund needs liquidity (cash) in a volatile market;  and if the debt instruments in the fund are designed with opaque valuation problems and/or have withdrawal limitations that prevented converting the fund’s debt assets to cash, then an LDI investing strategy may subject the pension fund to a potential liquidity crisis–such as that faced by the UK government pension fund in Sept. 2022.

About the Author

Kevin McBride is a Pension & Benefits Litigation Attorney in Los Angeles, California, USA.

He is admitted into three California US District Courts (Central, Southern, and Northern), the US District Court for the District of Utah, the Ninth Circuit Court of Appeals, and the Federal Circuit Court of Appeals. McBride holds a BA degree in Economics from the University of Utah and a JD from the University of Utah College of Law, where he served on the Utah Law Review. He is a member of the Federalist Society and the Federal Bar Association.