Passive LDI gives fake security – Pimco
EUROPE - Structuring liability-driven investing (LDI) as passive mandates can create a false sense of security as some pension funds thinks they are risk-free, bond fund manager Pimco has warned.
Jeroen van Bezooijen, senior vice president and product manager responsible for Pimco's European LDI business, claims it is virtually impossible to manage passive LDI risk free and in the last 12 to 18 months such portfolios have not delivered as they were supposed to.
"Many of these LDI strategies rely on interest and inflation swaps that are used to replicate liabilities, which are essentially derivatives contracts for which you have to pay a variable LIBOR interest, which is changed continuously," he said.
However, van Bezooijen, who joined Pimco's European LDI business from Goldman Sachs in March this year, thinks investors have occasionally overlooked the fact that this variable interest rate is not risk free.
Secondly, investment managers rely on actuarial estimates of projected actual future cashflows to analyse the risk characteristics of the liabilities and plan the LDI strategy, creating uncertainty over the actual payments.
Passively replicating estimated cashflows therefore creates a "false sense of security", according to the bond manager.
Pension funds have been disappointed by their investments in enhanced cash funds as part of their LDI strategy in the last 12 to 18 months as a result, says van Bezooijen.
"Assets like the triple-A tranches of CLOs, CDOs, asset backed securitisations, all these which paid for a long time the LIBOR coupon or even a bit more than LIBOR were all of a sudden worthless, reducing your cash pool to finance the floating ‘leg' of the swap," he said.
He agrees the development is down to market valuation and might change again for most assets, though warns with these type of funds there is a risk of getting a ‘run on the bank'.
"As a pension fund you might be able to wait and take a long-term position, but there might be other investors in the fund who do not have such patience," continued van Bezooijen.
Pimco instead believes liability risk characteristics can be reproduced in many different ways, for example through bonds, futures and swaps: "There are often structural opportunities to add value by exploiting the relative attractiveness of these different securities at any point in time."
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