| How to play your pension portfolio: Shell shuns LDI |
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| 26/11/2006 | |
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You must have heard of LDI solutions, the new marketing slogan to an old problem: how to capture performance without losing the liability-matching traits of a portfolio. The answer: create two separate portfolios: a performance-seeking one and a liability-matching one and then use "mathematical models for optimal asset allocation in relation to a fund's minimum funding ratio," says Lionel Martellini, Professor of finance at Edhec. But not all CIOs are buying into Liability Driven Investment (LDI) Solutions , especially those who oversee pensions with big surpluses. "We are return seekers," says Sijb Bartlema, CIO of Shell Asset Management in the Netherlands. "We are in a three-year bull market already. Given oil prices, our (parent company) is well positioned," suggesting that some pension plans can afford to run short-falls with their parents bailing them out. LDI investing is too expensive and excessive fees are spent on liability hedging costs, notes Bartlema. "We will have to live with surplus volatility," he says. "Investing is more art than science." Enter Prof. Martellini, who takes issue with such an approach. "(Bartlema) is saying essentially that 'my fund is in good shape and I want to take risks.' Why not, but to say that my sponsoring company, Shell, is very wealthy and I am self-insured in case of a shortfall because the parent can step in is very misleading in the context of asset-liability management. Deficit-saddled schemes In fact, the pension landscape is littered with deficit-saddled schemes, he argues, thanks to market downturns and lower interest rates. Many have used this adverse 'perfect storm' scenario of high equity allocations and declining rates to favour portfolios with a heavy weighting in bonds. Martellini's solution is more nuanced. He suggests CIOs maintain a heavy equity weighting if their funding position is healthy and scale back if their funding position deterorates. "If your funding ratio is closer or below the minimum, you lack margin power, so you should avoid allocating 75% of your allocation to equities," he says. "What is wrong is not a high allocation to equities, but not reducing that allocation as the funding ratio shrinks." The level of the funding ratio is set by the regulatory authorities in the EU zone. Switzerland and the Netherlands have particularly high ones at 100% and 105% respectively. The UK does not have an explicit one. V.B. |
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Articles of the same Topic : Portfolio management |
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