24th May 2011
Q: What is a liability driven investment (LDI)?
A: In a nutshell this is an attempt to match the returns on a portfolio with the present and likely future out-goings of a fund, normally a pension scheme, and, sometimes, an individual's spending.
LDI is designed to avoid excessive risk and works best where future cash needs can be predicted. A £100m pension fund whose liabilities to retired members is £4m this year, £5m next year and £6m the year after that, might, using LDI, invest largely in UK government bonds to make these payments. Other investment strategies might return more but at the risk of equity market or currency losses.
Some IFAs adopt LDI for retired clients needing a pensions earnings boost from their portfolio. They argue it is better to produce what is needed in a secure, low-risk or risk-free environment than gamble on higher returns at the potential cost of loss.