An approach that takes the liability rather than a market index as its benchmark, and whose derivative implementation introduces a permanent liquidity requirement.
Liability-driven investment reverses the reference point of portfolio management: performance is measured not against an index but against the movement of the liabilities, a pension scheme or life insurer seeking above all to have its assets move with its debts when rates move. Achieving that sensitivity with physical bonds would require devoting nearly the whole portfolio to them, so implementation runs through interest rate and inflation derivatives, which deliver the required sensitivity while tying up only a fraction of the capital. That is where the real exposure arises, because this capital efficiency is paid for with a permanent collateral requirement, and a rapid rise in rates, which actually improves the scheme's economic position, simultaneously creates an immediate liquidity need. The arrangement is thus fundamentally sound and operationally fragile, a configuration a funding ratio does not reveal. The lesson supervisors have drawn since 2022 is to measure hedging and resilience to a collateral shock separately, two questions the industry had long conflated.
In September 2022, the sharp rise in UK government bond yields after the 23 September fiscal announcement forced pension schemes using these strategies to sell assets to meet collateral calls. The Bank of England intervened on 28 September 2022 with a temporary purchase program to break the spiral.
LDI, liability-driven investment, gestion adossée au passif, pilotage par le passif