The UK Liability Driven Investment market continues to grow significantly, with hedged liabilities increasing 29 per cent to £657bn last year. However, wider DC pensions changes have inadvertently created scope for further growth in the market due to members ‘cashing out’ of schemes and realising benefits at their transfer value which link to prevailing yields, according to a report published by KPMG.
In its fifth annual report, KPMG’s LDI Survey 2015 found overall mandates increased 25 per cent from 825 to 1,033 in 2014. KPMG believe that, despite the historic low yields available, there remains strong demand for even more LDI.
Simeon Willis, head of investment strategy at KPMG, explained, “The pensions industry is increasingly becoming acclimatised to the new normal of low long term yields, continuing to increase hedging despite current levels. Further, the supply side of bond markets has shown that it can grow in size to meet investor demand at these yields. With the importance of hedging increasing as schemes inevitably reduce their other risks, it is not unthinkable that in the next decade we’ll get to a point where the typical scheme is fully hedged.”
In particular, the market saw a boost in the number of pooled mandates, which increased 41 per cent (with 151 new mandates) over 2014. For the first time there are now more pooled LDI mandates than segregated. Despite this growth, pooled mandates still make-up only 7.3 per cent in terms of the market by total liability hedged and smaller schemes (<£50m) remain poorly represented.
Barry Jones, head of LDI research at KPMG, commented, “The main battleground in LDI last year was for pooled mandates and we certainly expect competition to be red hot again this year.”
“There are now six main players fighting for market share and other providers bulking out their teams in hope of breaking into this long-term, lucrative market.” Barry noted that “Whilst similarities can be drawn between the various pooled fund offerings, each provider has their unique selling point in an attempt to stand out from the crowd and win business.”
Although competition was evident in pooled mandates, the survey revealed that overall the ‘Big 3’ – LGIM, Insight and BlackRock – continue to dominate the LDI market, accounting for 85 per cent of market share. Barry Jones commented “it’s hard to see this domination changing in the near term as LDI is such a “sticky” asset class, with high mandate retention. To put the ‘Big 3’ supremacy into perspective, you would need 3 times the total new client money allocated to LDI during 2014 going exclusively to one provider for one of the pack to catch any of the Big 3.”
The report also highlighted that, due to the new pension flexibilities, LDI strategies may need to be adjusted to reflect how and when benefits are actually taken. Simeon Willis noted “the pension freedoms offered within last year’s Budget have shaken things up significantly. This will no doubt have an impact on how and when benefits are taken from DB schemes in the UK and the shape of the LDI exposures. My guess is that the potential increased volume of members transferring their benefits out of DB arrangements, and crystallising 100% of the value using the market conditions at that time, will lead to a greater demand for trustees to use LDI going forward.”
The report can be downloaded here:
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Notes to Editor
LDI mandate definition - For the purposes of this survey KPMG has defined an LDI mandate as one which either has some sort of liability cashflow benchmark, or uses derivatives to gain exposure to nominal interest rate, real interest rate or inflation hedging, primarily for the purpose of liability risk management. Mandates simply with broad bond or gilt index benchmarks have been excluded, as have single stock funds.
Simon Chan, KPMG Corporate Communications
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This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.