LDI — Liability Driven Investing
An investment framework where portfolio structure is explicitly designed around the institution's future financial obligations rather than purely around return maximization.
LDI is primarily relevant to defined benefit pension funds with legally binding obligations to pay future retirement benefits. The core insight: a pension fund's liabilities fluctuate in present value as interest rates change, so a traditional equity-heavy portfolio creates a mismatch — assets and liabilities move independently, causing funded status volatility.
Key LDI tools include long duration bonds (20-30 year Treasuries and investment grade corporates), interest rate swaps (derivatives that hedge rate sensitivity), Treasury STRIPS (zero coupon bonds for precise duration matching), and glide path LDI (automatically increases hedge ratio as funded status improves).
LDI shifts the governance conversation from 'are we beating the benchmark' to 'are we improving our funded status' — a fundamentally different and more appropriate question for a pension fund.
Frequently Asked Questions
What is liability driven investing (LDI)?
LDI is an investment framework where portfolio structure is designed around an institution's future financial obligations — primarily used by defined benefit pension funds to align assets with future benefit payment liabilities.
Why do pension funds use LDI?
Pension liabilities fluctuate with interest rates. LDI uses long duration bonds and interest rate swaps to hedge this sensitivity, reducing funded status volatility and ensuring the fund can meet its obligations.
What tools are used in LDI strategies?
Key LDI tools include long duration bonds (20-30 year Treasuries), interest rate swaps, Treasury STRIPS for precise duration matching, and glide path approaches that increase hedging as funded status improves.
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