The total value of defined benefit pension scheme liabilities hedged by liability-driven investment (LDI) strategies increased to almost £1trn at the end of 2017, meaning that nearly half of the UK’s DB pension scheme are now using LDI to reduce their exposure to hedge interest rate and inflation risk.

XPS Pensions Group has revealed that the total notional value of liabilities hedged by LDI strategies moved from £904bn to £965bn last year — an increase of 7 per cent.

Given the minimal movement in yields between the ends of 2016 and 2017, XPS said that almost all of this gain can be attributed to new LDI mandates, which increased by 17 per cent.

There were 312 new LDI mandates implemented in 2017, taking the total figure to 2,140. Only 28 of these were segregated and bespoke pooled mandates, showing the popularity of lower governance and pooled approaches.

Furthermore, 41 per cent of new mandates came through platforms and fiduciary management last year, which provide a means for schemes of any size to hedge their liabilities. The average value of liabilities hedged across new mandates was £195m, compared to £495m for existing mandates at the start of 2017.

In its first LDI survey, XPS warned other schemes looking at LDI that waiting for a bargain buying opportunity was likely to disappoint as attractive pricing only arises when the necessity for most schemes to protect against downside risk falls away.

“Even though gilt yields ended up where they started in 2017, yields fluctuated by 10-15 bps on a weekly basis, equating to a 1-3 per cent movement on the liability value for a typical scheme,” explained XPS.

XPS Pensions Group chief investment officer, Simeon Willis, said: “Waiting for a gilt buying opportunity is fine if you can afford to take the risk, but it is a very dangerous game and is why LDI is integral to UK pension scheme risk management.”

He added that new solutions were coming to the market, through fiduciary managers and platforms, to make LDI more accessible and affordable for small to medium pensions schemes, meaning that LDI was no longer the domain of larger pension funds.

“Whilst no-one knows the direction of markets, what we do know for sure is that LDI will smooth out the lumps and bumps, freeing up pension scheme investors to focus on the complex task of earning a return,” Willis added.

“When LDI is done correctly it is highly effective and as accessibility is improved more schemes are seeing the results of this. Contrary to some views out there, we believe there is still scope for further growth and waiting for a bargain buying opportunity is likely to disappoint as it will only arise when the necessity falls away - which will be too late.”

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