As discussed throughout our PROGRAMME materials, we believe the proper selection of an LDI benchmark is a key determinant in the success of an LDI strategy. In Multi-Level LDI Benchmarking (part two of four in this series), we recommend that plan sponsors consider establishing two separate “levels” of benchmarks, those being at the 1) plan level, and 2) investment manager level. At the plan level, 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. These 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.
In this whitepaper we focus on manager level benchmark decisions, which ultimately dictate not only how well the assets hedge the liabilities, but also the investability of the strategy. Given the importance of these issues and potential tradeoffs involved, we often field a number of questions regarding the finer points of benchmarking in LDI strategies. Of the many choices that plan sponsors face, some have been more widely debated while others don’t always receive the attention they merit. We have identified four key decisions that sponsors often face:
While much of the PROGRAMME framework establishes a structured approach to LDI, the decisions examined herein are highly dependent on the client’s particular objectives, risk preferences, investment philosophies, and their stage in the de-risking process. Rather than asserting opinions, this whitepaper seeks to elucidate considerations imbedded within these issues so that plan sponsors can make informed decisions on the specifics of their LDI benchmarks.