The South African pension fund industry is recognising that in today’s environment, liability driven investing (LDI) is the only viable framework to use in formulating an investment strategy. This is according to Prasheen Singh head of investment consultant RisCura Consulting.

A successful LDI strategy targets a customised benchmark defined by a fund’s expected liabilities, as opposed to a peer-based or market-related benchmark. 

Liabilities might be the pension obligations of a defined benefit (DB) plan, or the need to provide an acceptable level of retirement benefits to members of a defined contribution (DC) plan over time.

“Irrespective of how you think about liabilities, formulating a pension fund strategy with an LDI approach gives trustees peace of mind, because their assets recognise their future liability commitments,” says Singh.   

The conventional approach to setting a pension fund’s investment strategy has been to set a target return (as a proxy for the liability) and then structure the assets such that the fund’s actual performance matches this targeted performance.  But this approach doesn’t fully recognise the importance of meeting the fund’s future pension obligations.

The problem with the conventional approach was exposed when global financial markets took huge knocks in the early 2000’s and again in late 2008. Markets performed poorly, interest rates dropped and, as a result, liability values rose substantially, resulting in widespread deficits and decreased funding levels.

Singh says DB funds that correctly formulate an LDI strategy in accordance with the new guidelines of Regulation 28 of the Pension Funds Act are likely to have fewer concerns, as the key issues such as the need to minimise funding level volatility, make allowance for future pension increases and manage longevity risk will have been considered and would be managed. 

“Similarly, DC funds that follow these guidelines would be far better positioned to satisfy member income expectations. In a DC scheme, the true liability is the present value of the expectations that members have of their level of pension income when they retire,” she says.

Globally, threats like longevity and adverse equity and interest rate environments have contributed to the near demise of DB plans.  As a result, the risk of not having enough money in retirement now predominantly falls firmly on the individual member of a pension fund instead of the company.

“However, regardless of where the risk lies or the type of scheme, the industry is coming around to the view that LDI is the best framework to use,” Singh concludes.