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LDI in an Asian context

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In Europe, stricter solvency regulations for insurers and pension funds, combined with a deterioration of solvency and funding ratios, provided the strategic rationale behind the development of a new type of investment model.  In this model, the liabilities of the client provide the benchmark for the construction of the portfolio to ensure a stable development of capital or funding ratio.  With its roots firmly fixed in Europe, the Liability Driven Investment (LDI) model, with its strong focus on risk, is now being expanded across other regions including the US and Asia, where many of the larger sovereign wealth agencies, pension funds and insurance companies are beginning to take note.

Head of Asia Institutional Business Development for BNP Paribas IP, TF Cheng is enthusiastic about the opportunities for LDI and fiduciary management on the ground in Asia.  “The landscape for Asian institutional investment is changing rapidly. Asian investors are experiencing increasing levels of liquidity and wealth, and at the same time increasing liabilities.”

An integrated approach

So how does that play out in the market? Liability driven investment looks beyond the value of the asset portfolio and allows the fund manager to manage the assets in relation to the clients’ liabilities. “The search for higher returns, capital preservation and funding ratio protection, as well as higher standards of risk management tools are what make it a useful model for institutional investors,” according to Anton Wouters, Head of LDI and Fiduciary Management for BNP Paribas Investment Partners.

“These investors may consider LDI or fiduciary management, being an approach that takes into account the full investment portfolio and related services, as the successor of their existing management models.” BNP Paribas has developed a building block approach that comprises multi asset class investments, more fixed income related LDI solutions, manager selection and risk management overlay solutions.

The greater focus on risk that LDI and fiduciary management provide results in a much more stringent framework that enables a control mechanism to preserve value.  For Wouters and his team, it is a process that focuses on the monitoring and management of a number of client-defined risk parameters, in addition to the management of the investment portfolio.  The group’s risk management platform enables risk monitoring of the total portfolio from an asset allocation perspective to the level of the individual securities, whether or not the underlying portfolios are managed by BNP Paribas themselves.

Risk versus liability

“Certainly during the recent crisis a lot of the questions were asked about how LDI relates to insurance management and pension funds.  What was clear was that those who had matched interest rate risk to liabilities for example, usually did better than those who were not hedged against interest rate risk, although a lot of other market developments played a role here,” comments Wouters.  “People became much more aware of the concept of risks versus liabilities, and for us as an LDI manager, we are now facing tighter regulations and a governance structure, where trustees or insurance companies have become our strategic partners in the set up of new portfolios.  The result is much greater interaction between managers such as ourselves and the stakeholders, greater transparency, where educating our clients becomes absolutely paramount,” he adds.

Local Asian presence

TF Cheng shares Wouters’ enthusiasm for the opportunities for LDI and fiduciary management on the ground in Asia. However, concerns for insurers and pension funds in Asia are not identical to those facing Western economies and require solutions that are customised to their unique needs,” he notes.  For Cheng the lack of a common currency across the region is one issue that he says may be viewed as a perennial liability in itself.  “Add to that the development of the Chinese economy, and the internationalisation of the RMB and we have a variable that is going to become a specific factor in everybody’s computations in Asia.”

In addition to currency and inflationary concerns, Cheng also points to implicit liability issues, despite the largely defined-contribution scheme based pension market in Asia - for example a de facto “minimum” return expectation of pension members through years of high dividend payouts by national pension funds.

LDI represents a customised investment approach where you need to first identify a problem such as underfunding, inflation, or currency issues, and then custom-build a risk-aware solution to address that specific problem.  As such the methodology is highly relevant to Asian investors who face specific investment challenges,” he opines.  “Any fund manager that wants to provide investment solutions for Asian investors must first understand the driving forces behind the socio-economic transformation of Asian countries and markets.  For us, it is not just about investor education but also about educating the fund managers.  It is really a partnership between us, as the solutions provider who understands the evolving needs of our investors on the one hand.  On the other, it’s about educating investors through the sharing of experiences where the LDI approach has solved problems already existing in insurance companies and pension funds in Europe.  While the problems faced in Europe may not be exactly applicable, they will be made aware of how they can learn from the problem-solving process and the type of tailored solutions we can provide,” concludes Cheng.

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  • QN-2546

    Asset class: Real Estate Equity Fund (non listed).
    Asset region: Europe.
    Size: Total CHF 600m, approx. CHF 100-300m per fund investment.
    Closing date: 2019-06-28.

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