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Nobel laureate Merton says LDI “ill-conceived”

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GLOBAL – Nobel Prize-winning economist Robert Merton has said immunizing pension obligations through liability driven investment strategies is “ill-conceived”.

He noted that changed accounting rules are forcing companies to “confront the economic reality of obligations under defined benefit pension plans”, and finding that they are not affordable.

The result was a shift towards defined contribution and a growing interest LDI, which seeks to match plan assets with pension obligations.

“Both trends are ill-conceived as long-run solutions,” Merton and his colleague Roberto Mendoza write in an article in the Financial Times.

“Immunisation at the pension plan level may well represent a step forward from the conventional approach of investing a large proportion of a defined benefit plan’s assets in equities, but it is at best an incomplete one,” they write.

The two, co-founders of Integrated Finance Ltd., acknowledged that the shift to DC eliminates companies’ financial liability for pension provision.

But they argue that it does not provide individuals with advice and tools needed to save sufficiently and efficiently enough to ensure a satisfactory retirement income.

In 2004 Merton told IPE that the asset allocation of corporate pension funds has a larger than acknowledged impact on the economic value of the companies.

“You can’t look at pension assets in a vacuum,” the Harvard University Business School professor said. “The pension allocation has a big impact on the firm and the risk of the equity.”

Merton, who won the Nobel Prize in 1997, was one of the founders of Long-Term Capital Management, the hedge fund which almost precipitated a global financial crisis after the Russian debt default in 1998.

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