Multi-Level LDI Benchmarking

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Background

Benchmarking is one of the most intricate aspects of a Liability Driven Investing (LDI) framework, and arguably the single topic on which we receive the most questions. We previously outlined the LDI framework in the first whitepaper (of four) in this series, which introduced the Standish LDI PROGRAMME. This second paper dives deeper into the LDI benchmarking issue which prompts a fervent combination of curiosity and frustration among investors. It seeks to answer many of the questions we field on a regular basis, including, “What should the plan use as a liability-hedging benchmark?”

Executive Summary

When selecting liability-hedging benchmarks in an LDI context, plan sponsors often find their priorities conflicted between two competing primary goals, those being strong degrees of 1) liability matching, and 2) investability. Establishing a single benchmark that meets both objectives invariably offers investors a challenge. As part of the Standish LDI PROGRAMME, we propose a solution to this crucial element of the LDI puzzle.

Standish recommends that in most cases, two separate “levels” of benchmarks are appropriate, those being at the 1) plan level, and 2) investment manager level. At the plan level, defined benefit plan sponsors should employ a liability-based benchmark in order to assess how their overall investment strategy is performing relative to the liability return. At the investment manager level, one or multiple benchmarks among a range of investable benchmark approaches should be utilized for the primary purpose of assessing manager performance. The two levels of benchmarks should be linked through the establishment and allocation of a “hedge budget”, which is often closely related to the plan’s glidepath. Sponsors seeking the highest level of customization should consider a completion management approach, which we will address separately as a special case in the final whitepaper of this series.

In our experience, this tiered methodology has proven supportive of the achievement of sensible liability hedging aims, while improving the ability of plan sponsors to meet a variety of practical plan goals, including improved investment governance and simplified performance attribution.

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