A hypothetical large services company with a $450M defined benefit pension plan is looking for an investment solution where the interest rate exposure of the liability is explicitly matched and an additional 2% return is achieved above and beyond the liability target — a Liability Driven Investing approach.





We first carefully analyze the projected cash flows of the plan by using the actuarial valuation provided by the client. By discounting these cash flows with a swaps curve we can both understand the liability and examine its interest rate characteristics, based on our assumptions. We find that this plan’s liability exhibits duration of nearly 11.50 and the liability is 100% funded (on a Projected Benefit Obligation basis) by the assets of the plan. We engineer a portfolio of pooled LDI funds holding swaps portfolios which provide a key interest rate duration profile very similar to that of the liability. Forty percent of the plan’s capital is consumed by matching the liability exposure.

We then use the remaining capital to construct a portfolio of alpha (skillful actively managed strategies) which is used to provide a returns engine which aims to achieve the liabilities + 2% target. The alpha portfolio employs two market-neutral long/short strategies and seeks to provide roughly 2.5% expected active return vs. cash while taking on 1.50% expected active risk.

Taken together, these two portfolios are designed to meet the "liabilities + 2%" target and provide the flexibility to make alterations easily and economically.provide the flexibility to make alterations easily, in a cost-effective method.