Understand the investment template that dominates the pension industry
Liability-Driven Investment is the practitioner’s guide to this increasingly popular investment template. Already the dominant framework for pension schemes in Europe and the UK, the LDI market is expected to grow significantly with the shift from Defined Benefit to Defined Contribution, and then into Digital Asset Management - or Robo-Advice. With an aging population and significant under-saving globally, more and more finance professionals will need to know how to work within and around the LDI framework; this book provides clear explanations for the framework's usefulness and growing popularity to help practitioners find their bearings in and around the LDI space.
The ultimate goal of LDI is to move beyond simple asset value maximisation and ensure that investors have sufficient funds to pay liabilities. This informative guide digs into that basic premise to show the various mechanisms, guidelines and practices that make up the framework's "working parts."
- Discover the optimal investment strategies in multiple assets classes
- Understand the key characteristics of the instruments used, including bonds, interest rate derivatives, and inflation linked products
- Learn why pension companies and individual investors are moving toward LDI
- Explore the ways in which the explosive growth of Robo-Advice will change retail investment
Finance professionals have long been accustomed to shifting landscapes - it is taken as a given that prevailing thought and attendant practices will change over time - but the rapid expansion of LDI has taken many by surprise. Having already been established as the dominant framework for pensions, it is clear that the emphasis on LDI will only continue to grow. Liability-Driven Investment tells you what you need to know in order to work effectively with LDI.
Table of Contents
Preface xi
CHAPTER 1 Liability-Driven Investment and Multi-Asset Class Investing 1
Moving Beyond Modern Portfolio Theory: Introducing the World of Liability-Driven Investment 1
The Cult of Equity 6
The Pension Protection Fund 7
Summary 13
CHAPTER 2 Introduction to Investment Risk 15
Risk Management 18
The Importance of Risk vs Return 18
Quantifying Risk 19
Systematic and Nonsystematic Risk 19
Creating A Risk Profile 20
Summary 21
Some Basic Rules of Investment Risk 21
CHAPTER 3 Introductory Steps into the World of Multi-Asset Class Investment 23
Some Handy Definitions 25
The Starting Point 26
Introducing Modern Portfolio Theory 27
More Handy Definitions 29
But How Does the Asset Allocation Decision work? 30
Home Country Bias: 32
Developing a Strategy for Multiple Asset Classes 33
Handy Definitions 34
Quick Aside: 36
Summary 36
CHAPTER 4 Building Investment Portfolios 39
(Fundamental, Technical and Quantitative Techniques) 39
An Introduction to Single Stock Selection 40
The Types of Analysis 40
Fundamental Analysis of Securities 41
Introducing Ratio Analysis 42
Liquidity and Solvency Ratios 43
Current Ratio 43
The Quick Ratio or Acid Test 43
Cash Ratio 44
Financial Leverage or Debt Ratios 44
Technical Analysis of Securities 45
The Main Assumptions of Technical Analysis 46
Quantitative Analysis 47
Passive Investors 48
The Passive vs Active Debate 48
Introducing the Efficient Market Hypothesis 48
So Why Use Active Managers? 51
So Passive or Active? 56
Summary 57
CHAPTER 5 Building Investment Portfolios 59
Choosing the Manager 61
Moving on to Operational Due Diligence 63
A Sample (Non-Exhaustive) List of Operational Checks 63
Quick Aside: Replicating Private Equity and a Passive Venture Capital Fund 65
Part 3 Portfolio Selection 69
CHAPTER 6 Moving Towards Liability Driven Investing 73
The Time Value of Money 73
More Extreme than the Extreme 76
The Basics Continued: Real Versus Nominal Discounting 77
A Simple and Brief Look at Bonds 78
Some Other Types of Bonds 79
How to Price a Bond 80
Key Terms 80
Immunisation Theory and Frank Redington 81
An Introduction to Interest Rate Swaps 82
What Is an Interest Rate Swap? 83
The Mechanics 83
Some Terms Used in the Market 83
A Quick Aside: Forward Rate Agreements (FRAs) 84
An Introduction to Inflation-Linked Securities 85
Why Do Governments Issue Inflation-Linked Bonds? 87
The Basic Mechanics 88
Inflation-Linked Swaps 89
The Global Market 90
Payers vs Receivers 91
The Zero-Coupon Swap 91
CHAPTER 7 The Defined Benefit Pension Plan and Explicit Liabilities 93
The Boots Example 95
The Stakeholders in a Typical Plan 97
A Checklist for Trustees 97
What Are the Liabilities? 98
CHAPTER 8 ESG, Governance and the Pensions Industry 101
The UN PRI 103
The Increasing Importance of ESG 105
What Does ESG Represent? 106
The Main Approaches to Ethical Investing 107
Screening and Beyond 107
ESG: A Screening Approach 108
Implementing a Screen 110
ESG: An Integration-Based Approach 111
Best in Class Positive Screening 112
Impact-Based ESG Investing 114
Engagement-Based ESG Investing 117
ESG in History 119
The Case of Cowan vs Scargill 119
Incorporating ESG into the SIP 121
The Revised Statement Should 122
CHAPTER 9 Moving Beyond Liability-Driven Investment 123
The World of CDI 123
What is the Difference Between LDI and CDI? 125
Credit Where It's Due 126
Moving into Illiquid Credit 126
Cash Flow-Driven Investment in Action 128
The ABC Scheme 128
What Are the Objectives of Our Typical CDI Scheme? 129
CHAPTER 10 The Statement of Investment Principles 131
Drawing up a Statement of Investment Principles 131
What the SIP must include 131
Preparing the SIP 132
A Sample Statement of Investment Principles 132
Statement of Investment Principles for the ABC Plan 132
Investment Objective and Strategy 133
Investment Strategy 133
Investment Restrictions 134
Investment Risk 134
Realising Investments 135
Responsible Investment 135
Additional Voluntary Contributions (AVCs) 136
CHAPTER 11 Liability-Driven RoboAdvice and the Development and Digitisation of the Industry 139
WealthTech: How Wealth Managers and their Clients are Embracing New Technologies 139
From WealthTech to Robo-Advice 143
Robo-Advice in Ten Points 143
A Brief Introduction to Robo-Advice 145
Pricing Structures for Digital Advice 147
Advice or Guidance: Robo-advice or Partially Automated Digital Guidance 148
From the FCA 150
Further Developments in LDI 151
The Evolution of LDI and the Creation of Cash Flow-Driven Investment 151
What is Cash Flow-Driven Investment? 151
The Evolution of LDI 152
INDEX 155
