Liability Driven Investing
WHY LDI NOW?
LDI strategies are attractive now for a number
of reasons, including:
• C
hanges in Financial Reporting
Requirements. Companies are now
required to report the funding status
of defined benefit plans on their
balance sheet, which can lead to high
balance sheet volatility. As the second
phase of financial reporting reforms
are implemented, income statement
volatility may also increase significantly.1
• C
hanges in Pension Funding
Requirements. The Pension Protection
Act of 2006 (PPA) toughened pension
funding rules by imposing a 100%
funding target, shorter amortization
periods, a modified yield curve
approach, and restrictions on the use of
asset smoothing. Subsequent legislation
has provided temporary relief from
some of those requirements.2
• Increased Pension Plan Operations
Complexity. Pension plan operations
are increasingly complex, in part
due to new requirements under PPA
with respect to the time-sensitive
certifications of pension funding ratios
(Adjusted Funding Target Attainment
Percentage or AFTAP) and the
introduction of AFTAP-based pension
plan restrictions, such as lump sum and
accrual restrictions. Therefore, stable
pension funding ratios are important for
plan operations.
Continued on back...
Liability Driven Investing (LDI) is an investment framework that focuses
on managing pension assets in relation to pension liabilities. LDI is
not new; in fact, similar strategies have been used for years under the
name of Asset–Liability Management (ALM). PNC Institutional Asset
Management∑ believes that LDI can be an effective tool in managing
pension plan risks.
A COMPREHENSIVE SOLUTION DESIGNED TO MANAGE PENSION RISKS
PNC Institutional Asset Management believes strongly in pension risk management. Our focus
is on helping clients analyze and manage the underlying risks in their pension plans. As a
complete LDI manager, we have wrapped the functions of a number of key service providers
into one comprehensive solution that may create cost and implementation efficiencies.
Our experienced team has crafted an LDI framework based on the following key components.
1
2
3
4
5
6
Initial
Analysis
ALM
Study
Dynamic
Asset
Allocation
Liability
Hedging
Strategies
LiabilityBased
Benchmarks
Monitoring/
Rebalancing
1. Initial Analysis
Our process begins with a comprehensive analysis of each pension plan’s specific
benefit provisions, as well as key economic and demographic assumptions, including:
• Liability cash flows and other demographics
• Contribution policy
• Funding policy
• Investment policy statement
• Other key elements of the pension plan’s operations
2.Asset-Liability Management Studies
The pension plan’s risk profile is analyzed based on Asset–Liability Management (ALM) studies,
carried out at the inception of the process and typically repeated every few years. ALM studies
are based on a probabilistic analysis, such as Monte Carlo simulations, and are well suited for
modeling pension assets and liabilities, which tend to be highly volatile and uncertain.
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• Increased Capital Markets Volatility.
Volatility of capital markets was
unprecedented in recent years, leading
to significant volatility of pension
assets and liabilities, and resulting in
volatility of pension funding status, cash
contributions, pension expense and
balance sheet impacts.
• Improved Pension Funding Levels.
Funding levels of pension plans
rebounded significantly after the credit
crisis of 2008, while declining slightly
during 2014. Generally improved
funding levels make LDI strategies
more appealing today than in the past as
companies see an opportunity to lock-in
recent gains.
• Rebounding Interest Rates.
Even though interest rates remain
at depressed levels, they increased
significantly during 2013, while
declining somewhat in 2014, making
LDI strategies more attractive now
than in the past.
3. Dynamic Asset Allocation
A key feature of our LDI framework is dynamic asset allocation or glidepath. The implementation
of an LDI strategy typically starts with a small (if any) pre-determined percentage of assets
allocated to the liability hedging assets. Over time, if and when funding status improves and
according to the glidepath schedule created and adopted at the inception of the LDI strategy,
periodic rebalancing will lead to an increased allocation to the liability hedging assets.
4. Liability Hedging Strategies
Once the dynamic asset allocation is established, we work with clients to determine whether
a liability hedging strategy is an appropriate fit for them. If so, a number of strategies are
considered in order to create a so-called liability hedging asset class, which is designed
to highly correlate with (and therefore hedge) pension liability.
5. Liability-Based Benchmarks
The main objective of an LDI strategy is to optimize the pension plan’s funding status. As
a result, an appropriate benchmark for LDI strategies is the “return” on a pension plan’s
liabilities. Plan-specific liability-based benchmarks are created and customized for each
plan in order to assess the performance of the LDI strategy.
6. Monitoring and Rebalancing
Monitoring is an essential part of our LDI framework with market values of pension assets
and liabilities determined on a regular basis. Once the thresholds are reached (as specified
by the dynamic asset allocation decision rules established at the inception of the strategy),
asset rebalancing is initiated and any funding status gains earned are locked in.
WORK WITH US TODAY
1 Financial Accounting Standards Board statement
ASC 715 (2006).
2 The Moving Ahead for Progress in the 21st Century Act (2012).
PNC Institutional Asset Management believes strongly in pension risk management. Our focus is
on helping clients analyze and manage the underlying risks in their pension plans. We built our
LDI framework on several key components — ALM studies, dynamic asset allocation, liabilitybased benchmarks, numerous investment options, and sophisticated reporting — integrated into
a single, comprehensive solution that may create cost and implementation efficiencies.
For more information, contact your Business Development Officer.
The PNC Financial Services Group, Inc. (“PNC”) uses the marketing name PNC Institutional Asset Management∑ for the various
discretionary and non-discretionary institutional investment activities conducted by PNC Bank, National Association (“PNC Bank”),
which is a Member FDIC, and investment management activities conducted by PNC Capital Advisors, LLC, a registered investment
adviser (“PNC Capital Advisors”). PNC Bank uses the marketing names PNC Retirement Solutions∑ and Vested Interest® to provide
non-discretionary defined contribution plan services and PNC Institutional Advisory Solutions∑ to provide discretionary investment
management, trustee, and other related services. Standalone custody, escrow, and directed trustee services; FDIC-insured banking
products and services; and lending of funds are also provided through PNC Bank. Securities products, brokerage services, and
managed account advisory services are offered by PNC Investments LLC, a registered broker-dealer and a registered investment
adviser and member of FINRA and SIPC. PNC does not provide legal, tax, or accounting advice unless, with respect to tax advice, PNC
Bank has entered into a written tax services agreement. PNC does not provide services in any jurisdiction in which it is not authorized
to conduct business. PNC does not provide investment advice to PNC Retirement Solutions and Vested Interest plan sponsors or
participants. PNC Bank is not registered as a municipal advisor under the Dodd-Frank Wall Street Reform and Consumer Protection
Act (“Act”). Investment management and related products and services provided to a “municipal entity” or “obligated person”
regarding “proceeds of municipal securities” (as such terms are defined in the Act) will be provided by PNC Capital Advisors.
“Vested Interest” is a registered trademark and “PNC Institutional Asset Management,” “PNC Retirement Solutions,” and “PNC
Institutional Advisory Solutions” are service marks of The PNC Financial Services Group, Inc.
Investments: Not FDIC Insured. No Bank Guarantee. May Lose Value.
©2014 The PNC Financial Services Group Inc. All rights reserved.
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