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Liability-Driven Investment. From Analogue to Digital, Pensions to Robo-Advice. Edition No. 1. Wiley Finance

  • Book

  • 176 Pages
  • March 2021
  • John Wiley and Sons Ltd
  • ID: 5838478

Understand the investment template that dominates the pension industry

Liability-Driven Investment is the practitioner’s guide to this increasingly popular investment template. Already the dominant framework for pension schemes in Europe and the UK, the LDI market is expected to grow significantly with the shift from Defined Benefit to Defined Contribution, and then into Digital Asset Management - or Robo-Advice. With an aging population and significant under-saving globally, more and more finance professionals will need to know how to work within and around the LDI framework; this book provides clear explanations for the framework's usefulness and growing popularity to help practitioners find their bearings in and around the LDI space.

The ultimate goal of LDI is to move beyond simple asset value maximisation and ensure that investors have sufficient funds to pay liabilities. This informative guide digs into that basic premise to show the various mechanisms, guidelines and practices that make up the framework's "working parts."

  • Discover the optimal investment strategies in multiple assets classes
  • Understand the key characteristics of the instruments used, including bonds, interest rate derivatives, and inflation linked products
  • Learn why pension companies and individual investors are moving toward LDI
  • Explore the ways in which the explosive growth of Robo-Advice will change retail investment

Finance professionals have long been accustomed to shifting landscapes - it is taken as a given that prevailing thought and attendant practices will change over time - but the rapid expansion of LDI has taken many by surprise. Having already been established as the dominant framework for pensions, it is clear that the emphasis on LDI will only continue to grow. Liability-Driven Investment tells you what you need to know in order to work effectively with LDI.

Table of Contents

Preface xi

CHAPTER 1 Liability-Driven Investment and Multi-Asset Class Investing 1

Moving Beyond Modern Portfolio Theory: Introducing the World of Liability-Driven Investment 1

The Cult of Equity 6

The Pension Protection Fund 7

Summary 13

CHAPTER 2 Introduction to Investment Risk 15

Risk Management 18

The Importance of Risk vs Return 18

Quantifying Risk 19

Systematic and Nonsystematic Risk 19

Creating A Risk Profile 20

Summary 21

Some Basic Rules of Investment Risk 21

CHAPTER 3 Introductory Steps into the World of Multi-Asset Class Investment 23

Some Handy Definitions 25

The Starting Point 26

Introducing Modern Portfolio Theory 27

More Handy Definitions 29

But How Does the Asset Allocation Decision work? 30

Home Country Bias: 32

Developing a Strategy for Multiple Asset Classes 33

Handy Definitions 34

Quick Aside: 36

Summary 36

CHAPTER 4 Building Investment Portfolios 39

(Fundamental, Technical and Quantitative Techniques) 39

An Introduction to Single Stock Selection 40

The Types of Analysis 40

Fundamental Analysis of Securities 41

Introducing Ratio Analysis 42

Liquidity and Solvency Ratios 43

Current Ratio 43

The Quick Ratio or Acid Test 43

Cash Ratio 44

Financial Leverage or Debt Ratios 44

Technical Analysis of Securities 45

The Main Assumptions of Technical Analysis 46

Quantitative Analysis 47

Passive Investors 48

The Passive vs Active Debate 48

Introducing the Efficient Market Hypothesis 48

So Why Use Active Managers? 51

So Passive or Active? 56

Summary 57

CHAPTER 5 Building Investment Portfolios 59

Choosing the Manager 61

Moving on to Operational Due Diligence 63

A Sample (Non-Exhaustive) List of Operational Checks 63

Quick Aside: Replicating Private Equity and a Passive Venture Capital Fund 65

Part 3 Portfolio Selection 69

CHAPTER 6 Moving Towards Liability Driven Investing 73

The Time Value of Money 73

More Extreme than the Extreme 76

The Basics Continued: Real Versus Nominal Discounting 77

A Simple and Brief Look at Bonds 78

Some Other Types of Bonds 79

How to Price a Bond 80

Key Terms 80

Immunisation Theory and Frank Redington 81

An Introduction to Interest Rate Swaps 82

What Is an Interest Rate Swap? 83

The Mechanics 83

Some Terms Used in the Market 83

A Quick Aside: Forward Rate Agreements (FRAs) 84

An Introduction to Inflation-Linked Securities 85

Why Do Governments Issue Inflation-Linked Bonds? 87

The Basic Mechanics 88

Inflation-Linked Swaps 89

The Global Market 90

Payers vs Receivers 91

The Zero-Coupon Swap 91

CHAPTER 7 The Defined Benefit Pension Plan and Explicit Liabilities 93

The Boots Example 95

The Stakeholders in a Typical Plan 97

A Checklist for Trustees 97

What Are the Liabilities? 98

CHAPTER 8 ESG, Governance and the Pensions Industry 101

The UN PRI 103

The Increasing Importance of ESG 105

What Does ESG Represent? 106

The Main Approaches to Ethical Investing 107

Screening and Beyond 107

ESG: A Screening Approach 108

Implementing a Screen 110

ESG: An Integration-Based Approach 111

Best in Class Positive Screening 112

Impact-Based ESG Investing 114

Engagement-Based ESG Investing 117

ESG in History 119

The Case of Cowan vs Scargill 119

Incorporating ESG into the SIP 121

The Revised Statement Should 122

CHAPTER 9 Moving Beyond Liability-Driven Investment 123

The World of CDI 123

What is the Difference Between LDI and CDI? 125

Credit Where It's Due 126

Moving into Illiquid Credit 126

Cash Flow-Driven Investment in Action 128

The ABC Scheme 128

What Are the Objectives of Our Typical CDI Scheme? 129

CHAPTER 10 The Statement of Investment Principles 131

Drawing up a Statement of Investment Principles 131

What the SIP must include 131

Preparing the SIP 132

A Sample Statement of Investment Principles 132

Statement of Investment Principles for the ABC Plan 132

Investment Objective and Strategy 133

Investment Strategy 133

Investment Restrictions 134

Investment Risk 134

Realising Investments 135

Responsible Investment 135

Additional Voluntary Contributions (AVCs) 136

CHAPTER 11 Liability-Driven RoboAdvice and the Development and Digitisation of the Industry 139

WealthTech: How Wealth Managers and their Clients are Embracing New Technologies 139

From WealthTech to Robo-Advice 143

Robo-Advice in Ten Points 143

A Brief Introduction to Robo-Advice 145

Pricing Structures for Digital Advice 147

Advice or Guidance: Robo-advice or Partially Automated Digital Guidance 148

From the FCA 150

Further Developments in LDI 151

The Evolution of LDI and the Creation of Cash Flow-Driven Investment 151

What is Cash Flow-Driven Investment? 151

The Evolution of LDI 152

INDEX 155

Authors

Dan Tammas-Hastings