Liability-driven investment (LDI) is an asset–liability management approach that designs the asset portfolio around the size, timing, and risk profile of known obligations. It is used by defined benefit pension schemes and insurers to reduce funding volatility and to help ensure cash is available when benefits fall due. LDI techniques include cash-flow matching and duration matching. Schemes may also use interest rate and inflation swaps, gilt repos, and other derivatives to hedge sensitivity to market moves.
LDI for individuals In personal retirement planning the approach first sets aside assets for essential spending. Investors then add return-seeking assets for discretionary goals, often using bond ladders or annuities to match near-term cash flows, with the remainder taking market risk to grow future income.
LDI for pension funds Defined benefit schemes use LDI to align asset behaviour with the present value of promised benefits. Portfolios hold gilts and investment-grade credit, plus overlays such as interest rate and inflation swaps, to hedge discount-rate and inflation risk. The focus is on stabilising the funding ratio rather than maximising absolute return.
Objectives and liability benchmark Schemes choose a liability benchmark that reflects how they value obligations. The benchmark may reference gilt yields or swap curves. Inflation-linked liabilities are often hedged with index-linked gilts and inflation swaps. The discount rate under IAS 19 is based on high-quality corporate bond yields. Under US GAAP Statement No. 158 sponsors recognise the funded status on the balance sheet.
Hedge design and measurement Managers measure asset and liability sensitivity to rates and inflation. Many schemes target a hedge ratio based on PV01 (the change in value for a one basis point move) or key rate duration (sensitivity at selected maturities). Duration matching reduces the effect of small rate moves on the funded status. Schemes use curve and key-rate hedges when sensitivity varies by maturity. Overlays allow hedging while keeping cash for expenses and collateral.
Return-seeking assets and de-risking Most strategies include a return portfolio to close deficits and build surplus. Trustees often adopt journey plans that reduce growth exposure as funding improves. This is sometimes called de-risking or a glide path. The mix depends on covenant strength, time horizon, and risk appetite.
Implementation models Schemes implement LDI through segregated mandates or pooled LDI funds. Pooled funds give smaller schemes access to hedging and operational support. Segregated mandates allow more tailoring of curve hedges and collateral processes. Reviews after 2022 discuss how pooled structures, rebalancing, and collateral movement affected outcomes in stress. Trustees are expected to document collateral waterfalls and run regular tests of resilience.
Techniques Cash-flow matching - Trustees buy bonds that replicate expected benefit payments as they fall due. Duration matching - Schemes set asset duration to offset liability duration so that small rate moves have a limited effect on the funded status. Inflation hedging - Many funds use index-linked gilts and inflation swaps to match inflation-linked benefits. Overlays and repo - Managers employ swaps, futures and gilt repo to obtain hedge exposure while keeping cash available for collateral and expenses. Schemes often combine these methods in segregated mandates or pooled LDI funds.
Risk management and collateral LDI managers and trustees manage rate, inflation and liquidity risk and hold collateral to meet margin calls. Policies cover collateral ladders, eligible assets and liquidity sources, with stress testing against rate and inflation shocks. International guidance after the 2022 episode emphasises liquidity preparedness for margin and collateral calls, robust stress testing, and operational processes for collateral management.
2022 gilt market episode In late September 2022, UK Treasury gilt yields rose sharply and prices fell, with 30-year yields up by more than 100 basis points in four days. On 28 September 2022 the Bank of England announced temporary purchases of long-dated UK government bonds. The Bank stated it would carry out purchases “in a temporary and targeted way… to restore orderly market conditions.” Auctions ran until 14 October 2022 and purchases were later unwound. A Bank of England speech reported that the Bank ultimately bought £19.3 billion of gilts during the operation. On 10 October 2022 the Bank launched the Temporary Expanded Collateral Repo Facility (TECRF) to support market functioning by enabling banks to ease liquidity pressures facing their client LDI funds. It also widened gilt purchases to include index-linked gilts between 11 and 14 October. Subsequent analysis using trade-level data found that forced sales by LDI funds created price discounts on the order of 7% to 10% at the peak, and that pooled LDI funds sold more than segregated mandates due to recapitalisation frictions. The study reports pooled funds sold roughly 13 percentage points more of their gilt holdings and that discounts closed by the end of October. In March 2023 the Financial Policy Committee recommended that LDI funds be resilient to at least a 250 basis point yield shock, on top of day-to-day movements, and set out work for regulators to implement minimum steady-state standards. The IMF drew broader lessons for non-bank finance and stressed the need for stronger liquidity risk management and data on leverage.
Policy tools In October 2022 the Bank of England launched the Temporary Expanded Collateral Repo Facility (TECRF) to support market functioning and to help banks ease liquidity pressures facing their client LDI funds. The facility ran beyond the gilt purchase window and later closed. On 11 October 2022 the Bank widened purchases to include index-linked gilts until 14 October. In 2024 the Bank announced a contingent non-bank repo facility for periods of gilt market stress, aimed at insurers and pension funds and designed to be unattractive in normal conditions.
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