Defined benefit pension plan sponsors must consider the downsides of using a liability-driven investment strategy, particularly the role of interest rates, said Duncan Burrill, managing director and chief executive officer of the Canadian Broadcasting Corp. Pension Plan, during a session at the Canadian Investment Review’s 2023 Risk Management Conference.
However, he also noted the pension fund’s LDI strategy has helped it meet the needs of its members. “It’s sort of sad that it all comes down to one issue, but when interest rates are rising, you’re going to have hedging losses and when interest rates are going down, you’re going to have hedging gains.”
Forecasting interest rates over the medium term has become a key element in the CBC Pension Plan’s LDI model, he said, noting the level of hedging is directly related to the potential future direction of interest rates.
While the pension plan has benefited since transitioning to an LDI strategy in 2005, Burrill urged plan sponsors considering this option to go through a serious review. “I would not classify myself as an evangelist as it relates to LDI. We think it’s a good strategy for our plan and it’s worked well for our plan. It doesn’t work in all environments . . . . It’s not the one solution that’s going to fix all your problems.”
While he noted the CBC Pension Plan isn’t permanently attached to its LDI strategy, he added that his team views LDI as a philosophy rather than a hedge ratio. “You could have a lower hedge ratio because you believe strongly that rates are going to go higher, but you still think in that liability framework in the lineup with your core mission and purpose.”
As far as the downsides of an LDI strategy, Burrill said derivative overlays will increase the volatility of a pension plan’s going-concern funded status and will also affect asset volatility. Indeed, he urged other plan sponsors to avoid mistaking an LDI strategy for the elimination of risk.
“There are obviously people who will provide a perspective that [LDI is] a risk elimination or minimization. I think that’s an overstep in terms of over-promising what the strategy can deliver.”
Last year, the CBC Pension Plan performed a full asset mix and allocation review. “We were at that point where we had higher solvency and going-concern funded ratios, so we could move away from just massively protecting the downside and think a little bit more broadly.”
The LDI strategy works for the pension plan, but it has underperformed in the past, said Burrill, pointing to 2021 and 2022 when interest rates were on the rise. “If you’re focused on your objective of providing that pension promise and having a lower solvency funded ratio, then that may be something you’re willing to accept.”
Read more coverage of the 2023 Risk Management Conference.