Global Pension Crisis: Unfunded Liabilities and How We Can Fill the Gap

CHAPTER 8

Liability-Driven Alpha

Liability-driven investing (LDI) is an approach to pension investing that focuses on calibrating investments to match plan liabilities with plan assets. While this seems to be logical and make sense, it actually runs contrary to much of modern institutional investing wisdom. Perhaps the biggest reason for this is that most pension funds are quite separate in their management of liabilities (the province of the actuaries and pension consultants) and their management of assets (the province of the investment management team and investment consultants). Pension plans certainly have liabilities, and managers certainly invest employer pension contributions to generate enough income to meet those liabilities. However, prior to the last five years, it was quite commonplace to have poor investment results followed directly by investment decisions that further enhanced risk. They followed the classic “Hail Mary” passive approach to investing.

I call this Liability-Driven Alpha, and the name once again comes from the classroom. When I formulated the course, I was motivated by a desire to ensure that more of Johnson's investment management graduates better understood the pension market. My original focus was on the move to terminate defined benefit plans. The course title in early 2008 was “Defined Benefit Pension Plans in Transition.” As I mentioned in Chapter 7, that scintillating title drew all of seven students where my “Search for Alpha” course had drawn ...