LMP-1: P&I article on corporate & public pension plans

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gilgamesh
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Re: LMP-1: P&I article on corporate & public pension plans

Post by gilgamesh » Thu May 18, 2017 9:36 am

bobcat2 wrote:A definition of Liability Driven Investing (LDI)

LDI strategies are goal based investment strategies that seek to maximize the probability of reaching a financial goal. Often an LDI strategy is implemented by focusing on duration matching assets to future liabilities.
gilgamesh wrote:Bob, in a LDI, once you start matching liabilities to assets, could those assets be part of the rebalancing and be sold? Or is it a floor, not to be sold?


I believe as you can see from the above an LDI is simply an investment strategy that is goal based, as compared to conventional strategies which focus on trading off returns against risks with little regard for meeting particular goals for the investor. So yes, you could rebalance safe assets out of the floor in an LDI strategy, but it sort of defeats the purpose of the strategy, which is to avoid having to do just that. :)

BobK


BobK thank you!

It is kind of confusing....it defeats it's purpose but is allowed. :D

It's hard to pin down what a strict LDI is...For, instance

"Dedicated portfolio theory focuses explicitly on cash flows and time horizons. If done properly, it allocates to fixed income no more than the minimum funds necessary to generate the desired cash flows, and all other funds can be invested elsewhere."

And this definition seems to contradict what you said later...

"Or is it some sort of Rube Goldberg contraption in which there are two investment strategies awkwardly compartmentalizing a large portfolio into two smaller portfolios - one driven by a traditional benchmark driven strategy and the other driven by some sort of LDI matching strategy? If so, that doesn't make much sense. For your portfolio you need a single strategy, not two non-overlapping, non coordinated, sub-strategies."

If LDI allows all other funds to be invested elsewhere, isn't it advocating a traditional benchmark driven strategy for all of these 'other funds'. It looks like LDI allows for this compartmentalization.

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bobcat2
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Re: LMP-1: P&I article on corporate & public pension plans

Post by bobcat2 » Thu May 18, 2017 2:16 pm

gilgamesh wrote:If LDI allows all other funds to be invested elsewhere, isn't it advocating a traditional benchmark driven strategy for all of these 'other funds'. It looks like LDI allows for this compartmentalization.
I don't see it that way. An LDI strategy is focused on meeting your financial goal. If you have enough safe assets to meet the goal, but have additional space in the portfolio, you can invest that additional portion of the portfolio in risky assets to better the goal. For instance, the goal might simply be a floor level of retirement income. Once you have dedicated enough safe assets to meet that floor you can invest in risky assets beyond that. Even though you are only covering the floor, it's still a LDI investment strategy focused on meeting the goal.

Conventional financial strategies focus on the trade off between risk and return. For instance, I believe I will not panic during a steep market decline with as much as 80% in equities. Therefore, I will have 80% in equities. You can do that, but you certainly aren't focused on hitting a financial goal. The spread of outcomes will be very broad. With many possible outcomes being far above the goal and other outcomes being far short of the goal. LDI strategies OTOH focus on meeting the goal and give up the opportunity to exceed the goal, until and unless the goal is safely covered.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

gilgamesh
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Re: LMP-1: P&I article on corporate & public pension plans

Post by gilgamesh » Thu May 18, 2017 6:51 pm

bobcat2 wrote: ...An LDI strategy is focused on meeting your financial goal. If you have enough safe assets to meet the goal, but have additional space in the portfolio, you can invest that additional portion of the portfolio in risky assets to better the goal. For instance, the goal might simply be a floor level of retirement income. Once you have dedicated enough safe assets to meet that floor you can invest in risky assets beyond that. Even though you are only covering the floor, it's still a LDI investment strategy focused on meeting the goal.

BobK


First thank you for your response.

The above nicely highlights what I wanted to clarify next. Say if the floor is for all my basic needs and thus will be 70% of my final portfolio.

Do I do a strict LDI until I amass 70% of my nest egg and then invest in risky assets. This will be right opposite to what many want to do - bonds only, in early accumulation, shifting to stocks closer to retirement. Or, each year investements are made to maintain 70% in LDI and 30% into risky assets ?

I assume it's the former, as the purpose first and foremost is to achieve my basic financial goal.

Thanks!

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Re: LMP-1: P&I article on corporate & public pension plans

Post by bobcat2 » Thu May 18, 2017 8:41 pm

gilgamesh wrote:
Do I do a strict LDI until I amass 70% of my nest egg and then invest in risky assets. This will be right opposite to what many want to do - bonds only, in early accumulation, shifting to stocks closer to retirement. Or, each year investements are made to maintain 70% in LDI and 30% into risky assets ?

I assume it's the former, as the purpose first and foremost is to achieve my basic financial goal.
No. It's difficult to do duration matching long before retirement, not to mention reality my change the plan as you get closer to retirement. If you are planning to retire at age 65 the matching begins in your early 50s and the heavy lifting on the matching occurs between ages 55-65.

Typically with an LDI retirement strategy there is a very significant allocation to stocks (95%-85%) before age 35, then a gradual decline in equity allocation until the early 50s when the duration matching begins, and a steep decline beginning in the late 50s. If one were to do a generic LDI for people in general, there would typically be an equity allocation of about 25% at retirement age 65. However, that is only an average and most individuals will vary from the average. But that variation wouldn't get you above 40% very often. :D

BobK

edited out double word "of"
Last edited by bobcat2 on Fri May 19, 2017 9:01 am, edited 1 time in total.
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

gilgamesh
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Re: LMP-1: P&I article on corporate & public pension plans

Post by gilgamesh » Fri May 19, 2017 5:54 am

bobcat2 wrote:
gilgamesh wrote:
Do I do a strict LDI until I amass 70% of my nest egg and then invest in risky assets. This will be right opposite to what many want to do - bonds only, in early accumulation, shifting to stocks closer to retirement. Or, each year investements are made to maintain 70% in LDI and 30% into risky assets ?

I assume it's the former, as the purpose first and foremost is to achieve my basic financial goal.
No. It's difficult to do duration matching long before retirement, not to mention reality my change the plan as you get closer to retirement. If you are planning to retire at age 65 the matching begins in your early 50s and the heavy lifting on the matching occurs between ages 55-65.

Typically with an LDI retirement strategy there is a very significant allocation to stocks (95%-85%) before age 35, then a gradual decline in equity allocation until the early 50s when the duration matching begins, and a steep decline beginning in the late 50s. If one were to do a generic LDI for people in general, there would typically be an equity allocation of of about 25% at retirement age 65. However, that is only an average and most individuals will vary from the average. But that variation wouldn't get you above 40% very often. :D

BobK


Thank you! that makes a lot of sense.

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Re: LMP-1: P&I article on corporate & public pension plans

Post by BigJohn » Fri May 19, 2017 7:05 pm

bobcat2 wrote:I am even sure what is meant by a liability matched portfolio, other than something that hasn't been well thought out in a systematic way. Is it a misnamed investment strategy that is more or less synonymous with the more broadly excepted term LDI? Or is it some sort of Rube Goldberg contraption in which there are two investment strategies awkwardly compartmentalizing a large portfolio into two smaller portfolios - one driven by a traditional benchmark driven strategy and the other driven by some sort of LDI matching strategy? If so, that doesn't make much sense. For your portfolio you need a single strategy, not two non-overlapping, non coordinated, sub-strategies.

Bob, I set my asset allocation in retirement based on Dr Bernstein's LMP approach. I estimated my annual minimal living expenses and put 30 years worth of that into high quality, intermediate term bonds (to match that liability). The rest goes into TSM/TISM and gives me a 35/65 allocation target. Maybe we are talking past each other but I do not see this as two non-overlapping, non-coordinated sub-strategies. What am I missing?

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Re: LMP-1: P&I article on corporate & public pension plans

Post by grok87 » Sat May 20, 2017 6:44 am

BigJohn wrote:
bobcat2 wrote:I am even sure what is meant by a liability matched portfolio, other than something that hasn't been well thought out in a systematic way. Is it a misnamed investment strategy that is more or less synonymous with the more broadly excepted term LDI? Or is it some sort of Rube Goldberg contraption in which there are two investment strategies awkwardly compartmentalizing a large portfolio into two smaller portfolios - one driven by a traditional benchmark driven strategy and the other driven by some sort of LDI matching strategy? If so, that doesn't make much sense. For your portfolio you need a single strategy, not two non-overlapping, non coordinated, sub-strategies.

Bob, I set my asset allocation in retirement based on Dr Bernstein's LMP approach. I estimated my annual minimal living expenses and put 30 years worth of that into high quality, intermediate term bonds (to match that liability). The rest goes into TSM/TISM and gives me a 35/65 allocation target. Maybe we are talking past each other but I do not see this as two non-overlapping, non-coordinated sub-strategies. What am I missing?

No tips?
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Re: LMP-1: P&I article on corporate & public pension plans

Post by grok87 » Sat May 20, 2017 7:12 am

bobcat2 wrote:
Typically with an LDI retirement strategy there is a very significant allocation to stocks (95%-85%) before age 35, then a gradual decline in equity allocation until the early 50s when the duration matching begins, and a steep decline beginning in the late 50s. If one were to do a generic LDI for people in general, there would typically be an equity allocation of about 25% at retirement age 65. However, that is only an average and most individuals will vary from the average.

So i would interpret "early 50s" to mean "around 15 years before retirement"

The question of when to start building one's retirement liability matching portfolio (LMP) is an interesting one. Personally i started gradually building mine more than 20 years before my anticiaped retirement date- see this post
viewtopic.php?f=10&t=64679

Some folks have advocated waiting till more like 5-10 years before retirement. I understand the thought process behind this- can invest in riskier assets for longer- but i think it could be problematiic if there is a prolonged period of low interest rates at that time (much like we are in now...)
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: LMP-1: P&I article on corporate & public pension plans

Post by gilgamesh » Sat May 20, 2017 8:49 am

grok87 wrote:No tips?


BobK

LDI duration matches assets to liabilities, and as such eliminates interest rate risks. Does it also consider inflation?

P.S: It would of course make sense to consider inflation. However, most of the definitions only talks about interest rate risks and thus my question. I suppose, inflation is added to the needs by assuming a certain percentage of inflation? But, many LDI literature uses TIPS too. So, I am after the strict definition here. In the strictest sense, does LDI eliminate interest rate risks and inflation risks or only eliminates interest rate risks and manages inflation risks?
Last edited by gilgamesh on Sat May 20, 2017 11:45 am, edited 1 time in total.

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Re: LMP-1: P&I article on corporate & public pension plans

Post by LadyGeek » Sat May 20, 2017 9:41 am

From the first post, an acronym reminder:
grok87 wrote:LMP = Liability Matching Portfolio
...
note: LDI = Liability Driven Investments = LMP

gilgamesh wrote:
bobcat2 wrote:A definition of Liability Driven Investing (LDI)

LDI strategies are goal based investment strategies that seek to maximize the probability of reaching a financial goal. Often an LDI strategy is implemented by focusing on duration matching assets to future liabilities.
gilgamesh wrote:Bob, in a LDI, once you start matching liabilities to assets, could those assets be part of the rebalancing and be sold? Or is it a floor, not to be sold?


I believe as you can see from the above an LDI is simply an investment strategy that is goal based, as compared to conventional strategies which focus on trading off returns against risks with little regard for meeting particular goals for the investor. So yes, you could rebalance safe assets out of the floor in an LDI strategy, but it sort of defeats the purpose of the strategy, which is to avoid having to do just that. :)

BobK


BobK thank you!

It is kind of confusing....it defeats it's purpose but is allowed. :D

It's hard to pin down what a strict LDI is...For, instance

"Dedicated portfolio theory focuses explicitly on cash flows and time horizons. If done properly, it allocates to fixed income no more than the minimum funds necessary to generate the desired cash flows, and all other funds can be invested elsewhere."

And this definition seems to contradict what you said later...

"Or is it some sort of Rube Goldberg contraption in which there are two investment strategies awkwardly compartmentalizing a large portfolio into two smaller portfolios - one driven by a traditional benchmark driven strategy and the other driven by some sort of LDI matching strategy? If so, that doesn't make much sense. For your portfolio you need a single strategy, not two non-overlapping, non coordinated, sub-strategies."

If LDI allows all other funds to be invested elsewhere, isn't it advocating a traditional benchmark driven strategy for all of these 'other funds'. It looks like LDI allows for this compartmentalization.

My concern is for long duration bond funds. With a possibly shorter horizon in retirement, wouldn't it be prudent to start using more mid- and short-term funds to reduce volatility?

gilgamesh's post is suggesting the approach on "LDI" is inconsistent with treating everything you own as a single portfolio. One strategy covering everything seems like a good approach to me. This may be a bookkeeping exercise, but the complexity may deter investors.
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BigJohn
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Re: LMP-1: P&I article on corporate & public pension plans

Post by BigJohn » Sat May 20, 2017 12:00 pm

grok87 wrote:No tips?

Working on it. See this post, would value any input you have https://www.bogleheads.org/forum/viewtopic.php?p=3375400

Edit: I see you already did. I've got a follow-up question in discussion above.

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