MASTERCLASS: Liability Driven Investing - October 2019

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  • 01 hr 05 mins 44 secs
Liability-driven investing is an important approach for institutional investors and defined-benefit pension plans, as well as individual clients planning for retirement. The LDI philosophy helps mitigate risks tied to current and future needs and uses available assets to bring in strong returns to cover those liabilities.

In this Masterclass, four panelists discuss hedging strategies, diversification, pension risk transfer and more:

  • Kevin McLaughlin - Head of Liability Risk Management at Insight Investment
  • Mike Jarasitis - Institutional Portfolio Manager and LDI Strategist at Fidelity Investments
  • David Phillips - Director of Liability Driven Investment Strategies at Parametric Portfolio Associates
  • Brett Cornwell - Fixed Income Client Portfolio Manager at Voya Investment Management

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MASTERCLASS

Jenna Dagenhart: Welcome to Asset TV. This is your LDI Masterclass. Liability driven investing is critical for defined benefit pension plans as well as individual clients planning for retirement. The goal is to minimize risk time to current and future needs and use available assets to bring in strong returns to cover those liabilities. We'll cover hedging strategies and derivatives, pension risk transfer, and a host of other important topics. 

I'm joined now by our expert panelists, Kevin McLaughlin, Head of Liability Risk Management at Insight Investment. Mike Jarasitis, Investment Portfolio Manager and LDI Strategist at Fidelity Investments. David Phillips, Director of Liability Driven Investment Strategies at Parametric Portfolio Associates, and Brett Cornwell, Fixed Income Client Portfolio Manager at Voya Investment Management.

Gentlemen, thank you so much for joining me today on Asset TV.

Kevin McLaughlin: Great. Thank you, Jenna. It's great to be here.

Brett Cornwell: Thanks for having us. It's great to be here.

Jenna Dagenhart: Great. Well I want to start with a broad overview. What is LDI? Mike, do you want to kick us off with that one?

Michael Jarasitis: Sure Jenna, and thanks again for having me here today. That's a good question to start with and a question of what is LDI? That I get at a family barbecue. I don't think I've given an answer that anyone understands, but I'll try my best.

I think the way to think about it is it's managing your assets in relation to your liability. I think the scope we're all talking about here today is a pension plan liability. Rather than 10 or 15 years ago, I think the focus was always just assets and isolation. What's the best total return I can get for a given amount of risk? Now it's thinking about that asset return relative to the liability. What can move that liability value, typically is interest rates, and what assets can you invest in that move like the liability? That typically is long bonds. Not your entire portfolio needs to be long bonds to be LDI, but you want some part of it that has interest rate sensitivity similar to the liability.

David Phillips: I'd like to add to that. Obviously yes, LDI management is managing assets against liabilities. I tend to take a broader view of it. Traditionally you've lumped the fixed income assets as being the LDI assets, and you're managing interest rate exposure and the liabilities with that fixed income allocation, but I think of it more on broader terms. There are more things that go into managing liabilities and a pension plan other than just the fixed income, and that's more like managing the glide path that you're working with and even extending to other assets beyond fixed income.

Jenna Dagenhart: Brett, you want to chime in on that?

Brett Cornwell: Yeah. I think I would add onto that and just thinking about it a little bit more holistically, if you take a step back, and LDI is liability driven investing. When you think about why is the liability driving the investment process? Well it's because this liability represents a risk on a corporate balance sheet for a variety of reasons. I think based on that, when you're trying to manage that risk, there are strategies like my co-panelists have described, which are ways or philosophically ways to attempt and approach to manage this liability as opposed to a total return investment mandate. I think if you just break it down at the very basic level, what LDI means to me is it's about managing risk on corporate balance sheets.

Jenna Dagenhart: Mm-hmm (affirmative). There are a lot of things that LDI is, as you just mentioned, but there are also things that LDI isn't. For example, it's not a benchmark driven strategy, so Kevin, do you want to weigh on that?

Kevin McLaughlin: Yes. Like the gentlemen said, I think traditionally, if I go back in time, many people were happy to base their asset allocation and have benchmark based returns. For instance, whatever the typical benchmark data, suppose it returned 5-6%, that was great, but that wasn't so good when you looked at your liabilities. It could've gone up by 10-11%. Very much in the context of what these gentlemen were outlining is LDI became about well actually, I need to deliver asset returns related to my liabilities, so it's not so exciting to get alpha to a benchmark. What you really want to have is returns relative to your liabilities, and if you go a step more or beyond that, is to manage the risk of those returns relative to liabilities. Typically, in LDI, what we tend to focus on much more is funded status volatility and excess returns to liabilities as opposed to public benchmarks, so quite a different animal.

Jenna Dagenhart: Clients’ needs, and liabilities are your benchmark.

Brett Cornwell: That's right. I would just add one thing to what it's not. Sometimes, I don't know if you gentlemen would agree or disagree, but I often hear LDI as a strategy. I don't tend to think about LDI as the strategy or the end product, I think about LDI being a philosophy or approach because there's a wide array of things that can impact what LDI means based on where a plan maybe along it's glide path. It can mean a variety of different things. I think as David pointed out, it could, quite frankly, include a higher allocation to equities or risk seeking. I think, to me, when I think about what LDI is and is not, it's not the strategy, it's an approach and a philosophy in a way, again, to think about how can you minimize the impact of this liability as a risk on balance sheets.

Michael Jarasitis: I agree. I think the biggest challenge we see for planned sponsors adopting LDI is really, when you've taken on LDI, it's a philosophical change. Moving away from that success is assets return a positive number to success is how you define it in relation to your funded status. If you have a lot of risk tolerance for your funded status, you could have a high degree of equities, and you're still doing LDI.

Kevin McLaughlin: Yeah. I would say maybe the reason more and more people have adopted LDI over time is... Another phenomenon why it's become more popular is liabilities become much harder obligations on corporate balance sheets. In the old days, the liability was quite fuzzy, today it's quite clear. It's a hard liability and there are very strict rules around if you have a deficit, how you have to fund that deficit and recover from it. The implications of getting it wrong are much greater, which means there's much greater focus on what are my liabilities? How can I deliver the returns that keep me strong in a funded status position and how can I manage the risk? These are things that people didn't tend to think about in the past, but now they care about a lot, and hence why we spend so much time on it. I agree with my other panelists that it's more of a philosophy of managing a risk as opposed to do I punt it all in equities and try to achieve the highest return?

Jenna Dagenhart: I want to talk a little bit more about how this philosophy ties into the current economy. We are in the middle of the longest bull market on record, but the economy is certainly facing its fair share of challenges. There's the US-China trade war, Brexit, other geopolitical risks. We've also seen the yield curve inversion this summer, week manufacturing data, and a lot of people worried about a recession on the horizon. That being said, I want to touch on late cycle approach to LDI. How much does your investment outlook impact your hedging strategy?

David Phillips: Well, I'll take that for now. I think that it depends a lot on who you are, what your plan is, how you're situated. Every plan is different, every plan sponsor is different. Even a plan, you could have two plan sponsors with the exact same plan that may treat them differently. They may take a different approach to actually investing the assets around that. You have to think about how strong the corporation is, can they make contributions if things go wrong? Are they generating cash flows? How's it going to affect their earnings? Are they going to be put out of business because a downturn on the market occurs where they're not properly risk adjusted in their asset allocation?

You have to take that into account as well as the convictions you have about markets going forward. Low interest rates are a really good example of that, which is another topic. Are we coming to that?

Jenna Dagenhart: We will certainly cover low interest rates and negative rates as well.

David Phillips: Having convictions or understanding how the markets can move your plan around, and that actually influences the larger corporation actually has a big influence on actually handle what markets you are in.

Michael Jarasitis: Yeah, I completely agree. Everyone's favorite response, right? It depends, but we have a few clients, there are a few of them out there that are fully funded a frozen plan and they're in entirely LDI or hibernating as we call it, their portfolio, so their asset portfolios moving just like the liability, and we go in and we talk about its late cycle, trade wars, fed cutting rates, plunge in the 30 year, and we laugh about it because they don't care. At least their pension plan doesn't care, their business might care. But it doesn't really matter what's going on in the markets, they don't have to worry about it.

But most plans aren't in such a good situation. They are underfunded and need typically of some risk tolerance to try to have part of the portfolio working to outpace the liability. They are taking capital market risk and those things matter, and I think in that situation, have a capital market aware overlay, I think makes sense.

The funder status should always drive, I think, the overall asset allocation, so if you're 90% funded you should probably have a little less risk than if you're 80% funded. But in either situation, if you see an outlook where it's late cycle, where equities typically are more volatile and provide a lower return, and rates, even as low as they are, tend to peak in the late cycle, it may make sense to take a little risk off the table at the margin, or depending on the pension committee's risk tolerance and all those factors.

Conversely, if we saw a lot of clear signs that it was early cycle, where equities tend to really outpace bonds, outpace the liability, it may make sense at that time to tilt a little more towards risk.

Jenna Dagenhart: You bring up a great point there, how much does the status of the plan frozen, closed, open impact the LDI approach?

Kevin McLaughlin: Jenna, before we go there, if it's okay, I might just pick up what Michael said in your last question, often the greatest enemy of LDI is what is the outlook? Because frankly we're all experts in LDI, but we have no idea what the outlook will be. I think history shows that people's ability to forecast, forecast rates, forecast the outlook is pretty weak. What we're much more concerned about is typically the average client that we face is maybe either taking on too much risk or is taking the risk in the wrong ways, so what we want to actually have a conversation around is, "Well, is there a better way to achieve what you're trying to achieve? So, deliver your liabilities and manage the risk." Maybe change the governance and change the way they think about their problem.

The last thing we want to get caught up on is can we predict interest rates or the future? Because that can be a big impediment to making progress. Often LDI is about everything other than trying to guess the future outlook. If people have a view on interest rates, well there's ways to deal with that, but don't necessarily need to get caught up on do I know where the 10 year rate is going? That's another aspect we spend a lot of time on, but frankly we should get away from trying to predict the future because nobody has a good crystal ball.

Jenna Dagenhart: Yeah. One of my favorite finance books is “Hubris”, and that is the underlying theme. It's very difficult to predict the cycle.

Kevin McLaughlin: Yes. Yes indeed.

Jenna Dagenhart: Building off of that, how much does the plan status open, closed, frozen impact the LDI approach?

Kevin McLaughlin: I would say that the decision to close or freeze a plan is probably one of the big catalysts for people to embrace LDI, because once they close off the new liabilities accruing on the books, they realize that there's going to be an end point and end game. When they get fully funded, at that point they want to make sure that the assets are fully tracking the liabilities.

Often the first step for many on an LDI is this decision to close or freeze a pension plan, and then they get into much other things around funded status and things like outlook. Yes, it's a big consideration.

Brett Cornwell: I think that's right, and I would agree with that. I would take it one step further in to say that the funded status, whether it's open, closed, frozen, whether it's the funded ratio, I think all of that plays into it, but I think there's also a factor, and David touched on this earlier, which is you have to consider how large is the plan relative to the overall enterprise value of the company. I think what that informs is the degrees of freedom you have and how much risk you can take, which could ultimately inform the asset allocation.

Then taking that even one step further, I think you also have to look at not only the ability to make contributions, but also the willingness and the cyclicality perhaps of a particular industry that a company may be operating in.

I think the funded status is one piece, and I think at a high level we often refer to that and look at that to make some assumptions based on what we think might be an optimal asset allocation, but I think there's a variety of other factors when you start to dig a little bit deeper, that also inform what could be, I guess to use that word, an optimal asset allocation based on not only the funded status and the ultimate objective, but the variety of other metrics on ability to make contributions versus growth, to willingness to make those contributions versus other capital projects at the corporation and trying to compare what makes more sense and what's a more efficient use of that capital? I think that also all plays to what ultimately the asset allocation looks like. I think the funded status is an important part, but it's only one part.

David Phillips: Yeah, that's exactly right. I think that one thing you might find with plans that are closed is that maybe they're not in a position to continue funding their plans. It may the stronger corporations are the ones that actually keep their plans open, they want to continue providing benefits for their employees in this format, and so they're probably in more of a position to take on the risk that they may want to take on in order to pay for future benefits accruing by having a higher equity allocation or something like that.

Whereas a plan that's closed, that can happen with a healthy corporation or an unhealthy corporation, but the point is that they're winding the plan down and so they should, as they get better and better funded throughout the glide path, it makes a lot of sense to take a lot of risk off the table.

Michael Jarasitis: I was going to say I think, as they said, open versus frozen matters, but not as much as a lot of plan sponsors think it does. I've seen plan sponsors that say, "We have an open plan accruing benefits, I don't need LDI to play a small role." I think LDI always plays a role. Hedging assets, however you want to define them, long bonds are risk-free asset in an LDI context, in a pension plan context, and the ultimate diversifier and most efficient way to reduce funded status risk, so I think at a high level, if your plan is open versus frozen, you should probably take more risks at each stage along the glide path. Say a 90% funded, you might have a little more risk if you're open than a frozen plan. But it all depends as everyone has said.

We have a client that they decided to fully fund their plan, it's open, it's accruing about a 2-3% service cost a year. They went full LDI and they're just locking in the part of the benefits they've already accrued, and they just have a contribution schedule to fund the service cost every year. In effect, they've turned it into a DC plan. They have to pay every year, but it's a relatively known amount. Now they have the benefit of the plan's relatively small compared to the company, and they have some cashflow that they actually can access. Certainly not every plan sponsor is in that boat, but it just shows you that the devil's always on the details on when and how you should implement LDI, and open versus frozen is not the only gauge.

David Phillips: That goes back to what we were talking about earlier, is that one of the things I like to think about in terms of LDI is that it doesn't matter if you're open or closed, or if you're taking risks or anything else, it's all LDI. The whole strategy you're talking is LDI. LDI is everything.

Kevin McLaughlin: I was going to say Jenna, I like the way how Brett styled it, and maybe that's where we should have started is if you're an investment and you've got liabilities, it's all about taking a risk, and you should take risk relative to your capacity to bear that risk. That should be the starting point.

The next point then comes along, well if I'm spending a risk budget and I'm buying assets, I should spend that risk budget relative to my liabilities, and I expect to get paid and rewarded for taking those risks. Maybe we start at the wrong order, but we've eventually got there.

Jenna Dagenhart: Arrived at the final destination.

Kevin McLaughlin: Not quite the final destination, but we're going in the right dir...

Brett Cornwell: We're on our glide path.

Jenna Dagenhart: In the ride direction.

Kevin McLaughlin: We're making progress.

Jenna Dagenhart: We're on our glide path, I love it. On the topic of funding, I wanted to ask you what do you think the best strategy is to achieve full funding for those underfunded plans?

David Phillips: I think generally speaking, the best strategy is to contribute to the pension plan. That seems to be usually how plans get funded back up, is most of the time it's not necessarily through the investment returns, it really is just buckling down and making the contributions to fund up. There are different ways to that as well, like issuing debt or something like that, which is another topic altogether.

Brett Cornwell: Yeah. No, I would agree with that. Trying to outgrow the growth rate of your liability, it's proven incredibly difficult to do, at least without taking a lot of risk, and risk in these terms is defined between the variability of the liabilities and the assets. When you think about the growth rate of the liability and how that's computed, just trying to keep up with that growth rate in and of itself, again, is incredibly difficult, much less exceed that hurdle to actually grow your way out of it. I don't know what you guy have seen, but it seems to be pretty-

David Phillips: Yeah, I'd like to add something to that. As plans are freezing and terminating, or well, really freezing, and the duration of the benefits gets lower and lower, the benefit payments out of the plan become a higher and higher percentage of the assets, which makes it just that much harder to catch up if you're behind, and so contributions are the only way to get there.

Jenna Dagenhart: Sounds like the third one might be the best.

David Phillips: Most reliable.

Kevin McLaughlin: I think my panelists are relatively pessimistic, but maybe this is... There might be other ways to get it, but yes, there's only really two buckets. If you want to close a funding gap you either have to have asset returns which exceed your liability returns, or you have to make contributions. What most people are suggesting is that it's proving very difficult to achieve liability returns, because we're in an environment where interest rates have been falling. As interest rates fall, your liabilities go up, so even though the equity market been returning quite well, it's simply not keeping up with liabilities, so it's forcing many people to contribute.

I would say from us, from the LDI community, the biggest thing we can bring to our clients and to the market is helping people to understand that they need to hedge their liabilities, and once they've hedged their liabilities, then they can have much more confidence that the asset returns plus the contributions can actually deliver what they need to close the funding gap. That's the trick that many have missed and what's causing the most pain.

Jenna Dagenhart: What is Insight's approach globally to LDI? Not just here in the US, but also in the UK.

Kevin McLaughlin: At Insight we've been a pioneer in LDIs, so going back to the early 2000s. I think some of the things that we would echo is it's what already have come up on the panel, is our approach is to start with what is your real objective? What is the outcome you're trying to achieve? If we can understand this first principle, then we can help you design the most efficient investment strategy.

What typically happens is that many people have a risk budget which they're spending, which is not necessarily the most optimal way to take risk relative to your liability based investor, who needs to care about funder status, insolvency and the risk on the corporate balance sheet. It's having this starting with a liability, helping to achieve the outcome, and having a risk management philosophy is where we bring the most value to our clients.

Jenna Dagenhart: How does the LDI completion manager help with implementation, monitoring, as well as creating an integrated and wholistic approach?

David Phillips: A completion manager can help a pension plan in a variety of ways. Traditionally it's been more to look at whatever the underlying physical bond managers have, and then overlaying that with futures or swaps or something, to achieve the duration qualities that you want across key rates or total duration, or however you want to do it.

But a completion manager typically can do so much more than that. They can help you manage along a glide path so that when a trigger is hit, you can reflect that change in allocation immediately by putting on futures or some sort of a derivative overlay which gets you to the right allocation immediately or bumps up your hedge ratio immediately, and gives you time to work through the transition to get to that with your physical allocations.

In addition to that, it helps you maintain your balance of assets. You can use in order to keep the asset allocation you have, the exposures to broad asset classes so that you can take money where you need to pay benefits or whatever. It gives you a little more flexibility in the way that you're managing the overall plan.

Kevin McLaughlin: If I may say David, so typically you find in the investment industry, many asset managers are good at managing assets, they're not so good at understanding liabilities. The one key advantage of the completion manager is you can say, "Hey, this is the manager who cares about the liabilities, so they complete the asset strategy to the liabilities." One person who's got expertise can take care of that, that then frees up the other asset managers to do what they're good at and delivering their asset returns, and they don't have to worry so much about the liabilities. Although as everybody's pointed out, the whole strategy is about delivering liability, so everybody must care about it.

Jenna Dagenhart: Before we move on from late cycle and some of the other topics that we've covered, I do want to talk about discounting cash flows. Many plan sponsors have tried to replicate the performance of long investment grade corporate bonds, Brett, talk to me a little bit about the accounting process and investor exposure to credit events and downgrades.

Brett Cornwell: Yeah. Well if I could be as provocative as to say that I think it's nearly impossible to hedge a liability portfolio, and anything that we're going to recommend or do is going to improve things, but the methodologies in and of itself make it, again, nearly impossible, if not impossible to actually precisely hedge what's going on. Part of that has to do with the way the cash flows are actually calculated, so you assume cash flows based on planned demographics and actuarial assumptions. Those assumptions can change and vary, and so when you're thinking about the cash flow of a plan, you might have a pretty good idea, but if something changes like the mortality tables a few years back, that could completely alter the measurement of that expected liability.

But let's just for a second say that we could actually get very precise cash flow calculations and we knew exactly what they were going to be, I think the second element that I don't know if it gets enough of airtime or discussion about is really the way that the discount rate or the discounting mechanism to discount that liability to a present value, I think has also got some real key challenges embedded with the way that this happens.

The way that you think about it at discount rate is it's basically taking a pool of bonds that are in the universe today, typically AA or better, and you have this universe of bonds, and when they meet certain criteria to be included in a calculation you come up with this discount rate that's not actually observable, but yet you're still using this rate to discount these cash flows. In a perfect world, even if I was the asset owner and the investor, I wanted to buy exactly whose bonds, at the next measurement date, the bonds that in that universe to calculate that discount right, if there's been a downgrade, those bonds or that bond gets taken out of that universe. That's called credit ratings migration.

Now if I owned that bond, I'm actually going to experience loss. The price of that bond is going to react to the downgrade and spread movement, whereas the bond that was in that calculation, it just gets simply removed from the calculation. What you have is you have a discount rate that it's not directly observable and you can't actually buy them, or you could buy them, but the actual population used to create that discount rate can and will change, and therefore you're going to be subject to credit ratings migrations and downgrades, whereas the discount rate is not.

For all intents and purposes, that AA corporate discount rate is actually higher quality. I would say it's more of a combination between AA and some form of AAA, which is oftentimes when you're optimizing portfolios and trying to create a custom benchmark to mimic that liability return, it doesn't want just AA corporate bonds. It often wants AA corporate bonds and some higher quality instrument, treasuries for example, to really think about how to get these two things to behave more accurately.

Being a little provocative because of those assumptions that go into the cash flow projections, as well as the way that the discount rate in and of itself is derived, my view is that it's very difficult to create a portfolio of only AA or high quality corporate bonds that are going to behave in a similar fashion when this discount rate is not being subject to things like downgrades and market activity. I know that was a long-winded.

David Phillips: That was excellent actually, and I'm sorry to interrupt, but taking it a step further, when a company is putting a liability on their accounting statements, they're sometimes using a nonstandard curve that actually might be something the actuary has created where they're taking a basket of the bond like you said, but the first thing they do is they slice out the 60% that have the lowest yields, and then, to be fair, they take out the top 10% of yields as well. But you end up trying to bump the yield curve up to the point where you're getting lower liabilities, and when you do that over and over again, it may be a completely different set of bonds that is responsible for creating the yield curve. That just makes it all the harder to actually match the liabilities that really show up on the accounting statements.

Michael Jarasitis: That's a great point, and in all curves, especially those aggressive 60/90 curves, if you look into the bonds that are actually in there, it's predominantly university hospital bonds, they're illiquid, they don't trade very often. We've seen some, we look them up on Bloomberg and they were issued, they were bought by a life insurance company, and they haven't traded in four years. There's no way you can even buy that bond or hedge that specifically, so that's just what we call an investability of hedging a liability.

Kevin McLaughlin: I'll concur with these fine gentlemen, but to say what people often confuse in terms of LDIs is what is my liability and the liability I'm trying to hedge? How does the actuary discount that liability and the curve they might use? I would say in the same sense that the map is not the territory. Just because an actuary discounts a liability in a certain curve, that's not necessarily the ultimate liability that you will face. In the end, as an LDI investor, you must pay the cash flows as they fall due, so it's the cash flows that are your ultimate liability, and your goal should be to fund those cash flows in the most efficient way you can.

We spend a lot of time worrying about the discount curve that actuaries use, but that's not, in the end, the ultimate liability that people face. What we want to do really is hedge this risk that people have on their balance sheet, this PBO on the curve, but actually fun the real cash flows through time. This is a topic that comes up a lot and it causes a lot of friction is you like, in investment strategies, but it's something we're well used to handling at this stage.

David Phillips: Along those lines, if you are a completion manager, you're probably not managing your liabilities against the yield curve that the actuary's using. If they're using something like that, it's usually a more standard yield curve that you actually have a chance of having some consistency from period to period.

Kevin McLaughlin: To be fair to the actuaries, they're using the discount curve for different reasons, and they have different regulatory reasons why they have to come up with a curve in the way they do. It's not their fault, it's just so happened to be this is the world we live in.

Jenna Dagenhart: Great. I like the map analogy as well.

Kevin McLaughlin: There you go.

Jenna Dagenhart: Well I know we're all very excited to talk about interest rates too, speaking of yield curves and whatnot. We're at a very different state right now than where we were at this point in time last year, when the fed was hiking rates. Well now the fed has had its second rate cut in more than a decade and we're seeing negative interest rates globally, so I wonder how does the current interest rate environment impact pension plans?

David Phillips: Yeah, so this is really an interesting question. It's a lot more complicated question than you make it sound. True, interest rates are really low compared to history. When I started in the actuarial business a really long time ago, interest rates were about 8% or something like that, so we're not getting back up there any time soon. In fact, a few years ago we thought interest rates were low, but they kept getting lower. They've just kept getting lower.

Instead of looking backwards, we need to look forwards a little bit and decide where we think rates are really going to go. Are we really in a low interest rate environment? Well, it seems like it, but the rest of the world has lower interest rates than we do, so maybe we're headed that direction instead. Again, you end up in a position where you look at the plan and you decide well, what kind of a position am I going to take based on the plan I have? If I've got a plan that's very well-funded and very well hedged already, there's really no reason why they should take a hedge off in order to take advantage of a bet that rates are going to rise. They should just stick with it because they're going to be worse off if the rates actually continue down. But if they don't take it off, they're going to be in the same place no matter what, which seems like a good place to be.

Now if you're underfunded and you're looking for places to take positions to try to close a funding gap, maybe you decide that taking that risk, which can be a significant amount of the surplus risk that you're dealing with, those mismatches between the interest rates and the assets and liabilities can really add up. You can take that, but you also have to consider whether you're actually really getting paid for that. Could you take that risk somewhere else in your portfolio and get a better payoff on average? Thin return-seeking somewhere or something like that.

Jenna Dagenhart: Interesting point with the curve. You never know how low we're going to go with the interest rates. Kind of a big game of limbo, where's the bar going?

Michael Jarasitis: I would agree. I think LDI really has very little to do with, we believe, in the current level of interest rates. It's about hedging downside risk. First of all, you could say, "Well, rates are so low, is there a downside risk?" First of all, that shouldn't even be your first question, it's what's your tolerance to downside risk within your firm?

What's second, and as Kevin said earlier, we agree, it's not a good strategy to try to forecast rates. The last 30 years have proven that. Then if you just look out today, even as low as rates are, are there plausible scenarios that could move the 10 and 30 year rate lower? I think there certainly are. That's not me making that call, but there's certainly plausible scenarios. There's a plausible tweet that could probably move them 25 basis points in an hour, so it all comes back to your risk tolerance and having that long-term strategic outlook.

Kevin McLaughlin: I think there's a lot of behavioral finance around interest rates. A lot of people have not hedged their liabilities for quite some time, and they've seen the interest rate curve come down, down, down. They're very reluctant to take that bet off right now, they want to be proven right through time. But what we're seeing is year on year is even though rates are low, they can go even lower again, so I think we tend to spend a lot of our time as how can we help you take the emotion and the behavioral finance out of this decision, and maybe put in place a framework that allows you to increase your hedge ratio over time, in a way that's less dependent on the outlook for interest rates?

Typically, that takes the form of glide path triggers, so funded status triggers, or simply triggers that can be put in place, reflective. If yields spike in a certain day or week, then we can do more hedging, or simply building the hedge ratio through time, so if I'm 50% hedged today, next year I want to be 60, the years after 70, the years after 80. Can we in some way dollar cost average the decision?

If we can build a framework that takes the emotion out of it, I think that's much better than trying to put all of your chips in one basket, which is to predict the outlook of interest rates, which has everybody has proven, we have no great ability to foresee or forecast.

Jenna Dagenhart: Not a successful strategy to try to predict that.

Kevin McLaughlin: Yes. I wish it was, and I wouldn't sit her today Jenna if I could forecast the yield curve, but no, I do, and I just think there's just much better ways. We talked a little bit about fixed income, but you can buy a fixed income bond and earn the credit spread, and sit on that through time and be very highly certain that you can get that payoff, so why would I want to be an investment strategy that's very uncertain versus one that's much more certain for the same risk budget?

If you think about it, that's the ultimate goal. You have an outcome you're trying to achieve; how can you achieve it in much greater certainty? Some of the strategies you may deploy are going to be just much lower rewarded than others. Interest rates tends to be one of those that's not a great decision, although we all understand why people are in the current predicament they are in today and the emotions around it.

Jenna Dagenhart: People tend to be emotional with their money, as I'm sure you all have seen. Great. Well along this topic too of bonds, I want to talk about given the low cost of borrowing, do some of the plan sponsor concerns about maintaining a sizable allocation to corporate bonds have to do with issuer concentration risk? Brett, I'll let you take this one. I know it's something you're interested in.

Brett Cornwell: Yeah. I think the notion of issuer concentration, if we think about the timeline of LDI, I think if we frame it in terms of LDI 1.0 and 2.0, I think my panelists earlier were saying an LDI 1.0, the best assets you can own when you're going a long duration is to buy long-dated, high quality corporate bonds. I think that's worked okay, over the last number of years, but also what we've observed is that as you move along your glide path and you hit more triggers as Kevin pointed out, you're adding more corporate bonds, and so then it becomes this exercise there are a limited number of high quality corporate issuers that are available out there.

Then I think the exercise become, again, in this frame of monitoring and thinking about risk, risk isn't just the behavior of the assets to the liabilities, but it's also within the asset portfolio and are you comfortable with the amount of idiosyncratic credit risk that you have to all of these issuers? One of the topics that we talk about is as plan sponsors are adding to their liability hedging portfolios and hiring other managers, if they're hiring other managers that are buying all of the same instruments, are you really getting the diversification that you think you need from an idiosyncratic risk level? Not so much the behavior of the assets to the liabilities.

That's one of the, I suppose, areas we've been probing and pressing on as that was great for LDI 1.0, but I think as we move further down our glide paths and become better funded and having larger fixed income portfolios, are there perhaps some maybe, what have been coined maybe some unconventional assets to work into the mix, that could diversify this credit beta that's baked in here without eroding the value of this liability hedging portfolio and what its intended purpose is?

We believe issuer concentration is a very real thing, particularly along the lines of some of the larger corporate plan sponsors that have a heck of a lot assets allocated to the liquid names. By the way, we didn't even touch on the liquidity of the benchmarks used, so even if you're looking at the top 50 or 100 names, the liquidity drops off pretty meaningfully after that. We've talked a lot about why there are these pools here, it's to make benefit payments, and so I think liquidity also has to be a portion of this discussion of risk management and defining risk and how you're building portfolios, but certainly I think the notion of issuer concentration is one that I think if you're not talking about it, you certainly should be talking about it when you're building a robust portfolio.

Michael Jarasitis: Well, I've found that what we typically do, and this is you know the liability discount curve is AA or higher, we know that the universe, as we've mentioned, is small and illiquid, and depending on what you're looking at, the top 10 issuers can be almost 50%. You can't have a properly diverse file liquid portfolio in that universe, so how far do you expand? We typically go into BBBs, and that gives you a much broader issuer diversification.

Now you're taking on more credit risk there, so if you pair that with some treasuries, you get the credit quality similar to your discount rate and you're further diluting that issuer concentration across your whole assets, so I think that's part of starting to expand the universe to cut down on this issuer concentration issue, and then I think there certainly are other asset classes you can look at.

What we've found is that there are some options at the long end, but as you go down the curve, you can get much more into securitized areas where the duration is appropriate and they're vast liquid markets. We do see a lot of plans that have been frozen now for five, 10 years, that the duration of their plan is moving plan, so we're actually fielding a lot of questions on okay, now I need to move from a 12 year product to a 10 year product, or even we've had one to five product one client wanted to add to pair with their 14 year product.

David Phillips: Yeah, I'd like to add something on the credit spread exposure. I think as we go down the LDI path and we start thinking more in the total plan portfolio, you can get creative in terms of the ways that you're getting credit spread exposure. It doesn't all have to come from strictly bonds, there may be other places that I can get it.

Along those lines, as you're looking at the total plan portfolio again, you may actually already have a lot of credit spread exposure just starting in your return seeking assets, and you may not need as much credit spread exposure as you think as you're going down that glide path.

Kevin McLaughlin: Yeah, I think it's an interesting challenge everybody's pointing towards, but effectively what we're getting as we build more and more LDI strategies and it's more and more concentrated on long duration corporate bonds, you're suddenly adding back a problem you didn't have before, is that your investment strategies becoming very concentrated. You originally started out with hey, do I want to have a diversified set of risks and beys relative to my liabilities. This diversification problem within a fixed income at its total plan level is something we want to spend more time on as an LDI community. As people get better funded, this is something they will have to address.

You've two basic strategies, which is do I put all my eggs in one basket, and as Mark Twain said, "And watch that basket," or do I go back and try to diversify? I think the better, more robust strategy through time is to put more diversification in place, so it's searching for other ways to take credit spread risk and capture credit spread, and maybe even diversifying beyond that even further while still managing liabilities is what LDI 2.0 as Brett styled it, is becoming more about. This is not easy, but it's things that it can be achieved.

Jenna Dagenhart: For some of those plan sponsors looking to diversify outside of long corporate bonds, but I know you mentioned CMBS is one solution, securitized assets.

Brett Cornwell: Yeah. We pointed out earlier, I think it really depends on the overall duration of the plan as to what might make sense, but I think there are certain assets, if you're even thinking about building a portfolio, what assets make the most sense at which portions of the curve? Even if you have a 14 year or a 12 year plan, it doesn't preclude you from using things like high quality securitized assets on the front end, particularly if you're worried about some sort of cash flow matching or maybe making benefit payments while not having to sell or liquidate things from the longer end.

I think one of the other areas I think that we've seen a lot of interest in are really more along the investment grade private placements, and that's one of the things that I think has attracted a lot of interest, given it's still corporate bonds, they still have spread duration, but you're getting that idiosyncratic name diversification from a pool of issuers that do not tap the public capital markets. So to the extent that you can work those into the portfolio, you can help manage, I think, some of these other risks that we're talking about in terms of issuer concentration without eroding, again, what you're trying to achieve in terms of any sort of target spread duration or interest rate hedge.

The challenge with those is that typically the duration of those instruments is somewhere shorter than 10 years, and so it gets to, again, segmenting of course how you're using these instruments, and how you might be extending duration in other parts of the portfolio with either longer public corporate bonds or some sort of duration overlay from a completion manager. But I think the intent and the purpose is to look at what we have today, I'm not as witty or clever with the analogies here, but if you have all of your eggs in one basket, maybe you have different types of eggs in that basket in addition to other baskets of other assets.

I think there's a variety of ways, we're just trying to creatively think about addressing some of the other risks in portfolios, and intentionally being provocative with ideas that might be a little non traditional or unconventional, to just test and poke and prod, and to understand what is an efficient use of the risk budget and how can we really hedge and ultimately meet the objectives that we're trying to meet?

Kevin McLaughlin: The one om most concerned about Brett is long-dated BBB risk, so it's a very concentrated credit default exposure. As I sit here today and look at most of our pension plan clients of cash flows going out 10, 20, 30, 40, 50 years, we don't know when the next recession will be, but we know there will be one and we know there'll be some disruption to the long-dated BBB market. Having some sort of diversification around this particular problem, I think is worthwhile spending time and attention on, and as Brett has pointed out there, there are many other ways to capture a credit spread premium. Combining this with a completion framework, so we're back to our earlier conversation, may be a superior, more robust way to deliver your liabilities than just simply to add more exposure to a very already concentrated bet you have going on in the portfolio.

Jenna Dagenhart: What role can overlay instruments play on increasing flexibility as well as overall efficiency?

David Phillips: I'll take that. There's a lot more going on with the overlay than just managing interest rates if you want it to. You can do things like cash securitization, whether it's on the total plan basis or for individual managers who just are hanging onto cash for whatever reason.

You can manage a glide path. That's one of the most important ways you can use the overlay, is to manage a glide path as you go through it, so that you're instantly moving to the new allocation instead of waiting until the end of the month when you've missed your opportunity or something like that.

You can take positions, and very quickly, that you may not have been able to otherwise. You can get into the market or out of the market very quickly by using an overlay if you have a conviction or you feel like there's something that's worrying you that's going on in the market. The overlays, the various ways you can use overlays just gives you a way to manage your plan more flexibly and more precisely than you might otherwise.

Jenna Dagenhart: Yeah. Kevin, how do you think plans should be approaching the use of derivatives, and does that introduce leverage here?

Kevin McLaughlin: Yeah, I would sit echoing what the panelists have said, I think derivatives are a strategic risk management toolkit that you have, so they give you the greatest ability to... You can manage risk as well as managing returns, so a different way of saying it, you can manage more liability risk without having to sell assets or sacrifice returns. They are the best way you can achieve your objectives and the best way of managing risk.

Often, we find that there tends to be an aversion to derivatives. People, maybe they don't understand them, they don't understand why they might work, and the leverage questions often comes up. What we would say is what your real objective is, is trying to manage your liabilities, typically that's expressed by reducing funded status volatility, so what derivatives do is actually reduce your risk and reduce your volatility, so they're really risk reducing as opposed to adding leverage. Yes, they do come with a need to manage leverage on the derivative themselves, but ultimately these are a risk management tool and, in your favor, and helping you to achieve your goals as opposed to creating new problems.

The leverage side of derivatives has to be managed, but frankly, there are many experts in the market who can help you do that and it's not so complicated. What I find more surprising is people put their LDI strategy on long-dated corporate bonds, and then I mentioned the BBB, this is A, an exposure that's completely uncollateralized and you've got no coverage is this bond defaults, and particularly if you haven't well diversified. In a derivative space, even though you have leverage, the position is trued up overnight and paid for in AAA collateral government bonds, so it's a very safe way of managing risk. There are some things that come with that, but they can be easily managed.

Brett Cornwell: Yeah, and I think at the end of the day, I think part of the spirit of your question was the flexibility. I think they provide an incredible amount of flexibility as everyone's described, but also, I think it increases the efficiency of the portfolio as well as the efficacy of the hedge overall. It's not that you can manage an LDI portfolio without derivatives, but man, it sure is a heck of a lot easier to do it with. Then you're not necessarily being influenced by only what's available in the market to buy, now you're making relative value decisions, which bonds do I like, which ones so I don't? Then you can make adjustments at the overall level, whether It's within your portfolio or in the context of completion management, which we've touched on a few times as well.

I think just in the spirit, it makes it a heck of a lot easier with a lot more flexibility baked into what you're trying to do, as Kevin pointed out, without really amplifying, I would agree with him, the risk in the portfolio. There’re other risks that people just commonly accepted because well, that's what you do, whereas something like this, which could ultimately reduce risk, people are a little averse to. I think it's an interesting thought to explore and poke at just a little bit.

Michael Jarasitis: I would completely agree. Say something like a treasury's future contract is a way to reduce risk, and one of the more risk-free assets you could go into in an LDI context, but there is this aversion to it. There's more regulatory oversight, people have all leverage and bad connotations with derivatives, so some clients just don't want to touch it.

What we've found is the long-dated treasury strips market, which has really grown in the last few years, that can get you pretty close in terms of efficiency, or call it the most duration per dollar of fixed income invested, strips are pretty close to where treasury futures can get you, and typically a little cheaper than doing a derivatives overlay program, and all physical liquid bonds, so very flexible as well.

Kevin McLaughlin: I think we tend to find that yes, in the beginning, there may be some aversion to using new technology, new tools, but over time the flexibility and the logic of this in your strategy becomes more overwhelming. When people go on a liability risking journey, they often figure out well what's the biggest risk I should be concerned about today? First of all, I start to hedge the duration risk, and after a while I realize okay, great, I've hedged duration, but now I've got all this yield curve risk, how do I take out yield curve risk? Well maybe perhaps I need a completion manager and overlay manager, and now I'm less scared about using derivatives because I can see a real need and purpose for it.

I think as people gradually get onto the risking curve, they figure out the logic of the risk management toolkit, and most will end up in the right spot. As Michael's pointed out, you can do it with or without derivatives. Maybe life is easier with if it's well managed and well controlled, but you've different choices.

Jenna Dagenhart: Yeah. Building off of that, Mike, what is the appropriate investment universe right now for LDI?

Michael Jarasitis: Well, it's always changing right? But I think we hit on a good amount of this where if you start from that uninvestable, highly concentrated AA universe, how far can you first start spending out in corporate bonds? We've done a lot of research on this and we think you can go as far as BBBs, which certainly there's a risk there, but we don't think quite as much risk as a lot of people think right now because, I won't get into all the details, but a lot of the issue is that BBB went their intentionally and they're large, blue chip companies that we don't feel are candidates for default.

You can go onto BBBs and even maybe a smidge of BB of their long-dated BBs that were typically issued by a company that was a fallen angel, so a company that's been around a long time, not a more speculative BB name that typically only issues, say five years and under.

You can also go into non-corporate credit, so US dollar denominated sovereign issuers, and then as Brett was alluding to earlier, I think the long CMO market is probably under-tapped in an LDI context, but if you guys want to add from there, I think beyond there, I think that set gets you a very large, multi-trillion dollar market that's pretty liquid and diversified, and if you start to reach out from there, you do have to start to worry about the liquidity.

Kevin McLaughlin: I might say, I don't care what asset class you use, as long as you hedge your liabilities and pay your cash flows, when you're good. Beyond that, if you can be confident of doing those two things, your key goal should be to diversify as much as you can and have the right toolkit in place to last you through the journey. These LDI strategies have to last 10, 20, 30, 40 years, so you need to think more beyond what's the right asset class. Well what's the most robust way to build my strategy that it going to take me from where I am today to ultimately running off these liabilities?

Focus much more on the liability outcome, hedging liabilities and meeting your cash flow, the other things will take care of themselves. As these gentlemen have pointed out, there's other ways to close the funding gap. You'll get there if you spend the time working out your objectives and the best way to achieve those.

Brett Cornwell: I think one of the things we're starting to explore a little bit is you start to observe have insurance companies hedged their liabilities? Now I know they're not corporates, it's a whole different ball game to some extent, but the spirit is they're still trying to hedge a liability and what tools are they using? How are they allocating their general account assets to meet whatever the liability is in the future? What we've found is that when you're starting to explore a little bit about how they're doing it, they're introducing asset classes that a lot of times corporate pensions are not. We touched on investment grade private placements, that's one, I would also point to something like commercial mortgage whole loans, which gives you a whole uncorrelated benefit to portfolio.

I would agree with Kevin, I don't really care what the universe looks like, as long as you've defined the objective and then gotten a set of tools that can help achieve that objective. We've touched a little bit on liquidity, if you're in a multi-manager structure that's trying to hedge this liability, there can be different liquidity levels for different managers based on different needs and objectives that each manager is given.

I think one of the things we're also trying to explore a little bit is we don't have to be the manager, we can complement what other managers are doing as well, to the extent that maybe you do want to introduce something, again to the word, a little unconventional, or maybe we're not the liquidity portfolio, maybe that's another portfolio, but there can be a very clear measurable and explicit benefit of having an asset that might exhibit a little bit less liquidity versus some of the other more conventional assets.

I think in that context, as Kevin so eloquently put, I don't really care what the assets are, as long as they can help you meet the ultimate objective that's been laid out.

Michael Jarasitis: I think that's a great point. I've talked a lot about liquidity because I think it's often underappreciated, and pension plans have a lot of cash demands on them every month, but unless they're going to do a risk transfer, which is probably a topic we'll hit on, pension plans do have the benefit of being long-term investors, so you could segment part of your portfolio to less liquid areas and enjoy that illiquidity premium and not having to worry about getting rid of it in a fire sale.

Jenna Dagenhart: Well I think you're actually psychic Mike, because that was my next question, was about pension risk transfer, and David, I think this is something that you're very excited to talk about as well. Speaking of pension risk transfer, what are some of the cost and benefits of this de-risking strategy?

David Phillips: Okay, I'll start on this one, I'm sure the others have some comments to make as well. Pensions risk transfer is an interesting area in that a lot of plans are looking out there trying to unload a bunch of their liabilities to reduce the amount of liabilities on their accounting statements, but what a lot of people don't realize is that it's not a dollar-for-dollar exchange for risk. You can get rid of half your liabilities while still only getting rid of 25% of your risk, and by the way, if you wanted to just get rid of 25% of your risk, you could probably just change your asset allocation to get it.

There are instances where it totally makes sense to do these sorts of things. If you've got small benefits, if you've got a lot of participants who are causing your PBGC premiums to go way up because they're there, even though they're not really having much impact on the plan, by all means, it makes sense to get rid of those, but by and large, when you see a partial risk transfer, you're seeing a case where the insurance company's taking the easiest liabilities to work with and leaving you with the hardest liabilities to work with. The problem gets a lot harder once you've actually gone through that process.

Michael Jarasitis: Right, so you're left something that's harder to hedge and much harder to get rid of.

David Phillips: Right.

Jenna Dagenhart: The worst eggs in the basket.

Brett Cornwell: The rotten eggs.

Kevin McLaughlin: I would say, to be fair to the PRT industry, there's many other reasons why people may do a risk transfer, and they may be noneconomic or just other reasons, their resources are going away and they just want the pension problem to go away. But I would concur with what people are saying, is you need to think long and hard about a partial risk transfer because it'd make it more difficult to achieve your ultimate objective, which is to de-risk the entire plan and maybe offload the entire plan.

When we think about partial risk transfer, we think about three things, one, is it value for money? Often, you'll find it's cheaper to keep the asset's liabilities on the corporate balance sheet. Two, as people pointed out, you need to think about the residual portfolio, how you're going to manage that, and third, and I think the one really underappreciated is, and maybe David was alluding to it, if you have a plan that's 90% funded and you sell off 50% of the liability, and it costs you 55, then suddenly your assets, you've got, if I do the math quite right, you've got 35 of assets less to close a dollar gap of 15. You're levering the assets that are left behind. They still have to close the same dollar gap, and even a bigger dollar gap was left behind, but what if it goes wrong? What if your assets don't perform? How are you going to close that gap? You'll be forces to make contributions.

I think these partial risk transfers could increase long-term contributions for many plan sponsors, and that's often against what their started goal would be, so you have to think carefully about them. There may be some reason they make sense for small plan benefits, but at the bigger scale, it's more complicated.

Michael Jarasitis: Those are key points. I could agree more. A partial risk transfer can be very seductive because it reduces liability on your balance sheet, but you really want to model very carefully what the post-transfer reality is going to be, because your funded status is going to be lower, and as we said, you're going to have higher risk levels, a harder liability to hedge.

Jenna Dagenhart: Kevin, what are some of the pros and cons of pension risk transfer versus hibernation?

Kevin McLaughlin: Ultimately the goal of pension risk transfer is to get everything off your books. That's one here we talk about as a full termination as opposed to a partial retiree transfer. The full termination is going to be very much an objective for many.

I think for smaller pension plans that have very high fixed costs of running their pension plans, maybe there's strong economics for a full risk transfer down the line, but if you're a large or a mid-sized plan, it's just simply going to be much cheaper to run off the risk on your balance sheet.

The first is cost, the second is how do you want to manage your risk, then everything else comes into the mix, so if you want to keep this on your books, then you actually have to find managers you like and you want to work with, and you have confidence in, that can help you on this de-risking journey. It's much more the human stuff comes in after the hard logic and economics.

These are things people go through. David also mentioned the effect on corporate balance sheets and corporate financial statements. Typically, if you do a risk transfer, there's going to be an effect on your profit and loss, and a change in your balance sheet. This can be a constraint for some, and they don't want to touch a partial risk transfer or a full risk transfer because it has effects that they don't like. There's a whole host of reasons, cost, risk and everything else.

Jenna Dagenhart: Great. Anyone have anything they want to add on PRT?

Michael Jarasitis: No, I was just thinking the pros are pretty obvious. If you can get rid of your entire liability through a risk transfer, that is the ultimate form of de-risking. There's no oversight, there's no risk, but it can be very challenging to get there and there are a lot of costs and capacity constraints along the way.

The final three to six months before a risk transfer involves a lot of team capacity. There's a lot of audits, you have to go to bid for the insurer, regulatory filings, this all takes up a lot of time, and we see plan sponsors that there's a bit of a catch 22, they want to get rid of the plan because they don't have the capacity to focus on DB and DC, but then that means they certainly don't have the capacity to focus almost entirely on DB for six months leading up to it.

Then it is very expensive in the short-term, even though the long-term, it's you're not paying anything once it's gone, but that break even versus keeping it on the books, say hibernation versus all the costs you incur for the transfer, sometimes it can be many, many years for that break even to work out. A lot of it has to do with how many retirees you have.

But one thing that we've seen that's killed a lot of deals for plan sponsors is there's this unrecognized loss, typically on a balance sheet, relating to the pension expense that they amortize over seven years, and when the transfer, you have to recognize it all at once. That is a cost that, like said, it just isn't really palatable for some plan sponsors. That's a number to look at.

Kevin McLaughlin: I think it's the settlement charge, so you have to mark to market everything on your books, these unrecognized losses come due all in one year, and they have to be recognized in the current year, profit and loss. Some don't want to do that for obvious reasons.

Jenna Dagenhart: Great. Well it's clear that there's a lot of energy and enthusiasm for LDI on this panel, and I'm sure we could talk about LDI all day, but in closing, I'd like to end by looking forward. What do you all see in the LDI space philosophy, as Brett coined, going forward?

Brett Cornwell: Well I think there's a lot more heightened awareness in going forward, a sensitivity. I think Kevin mentioned this earlier, which is ultimately reducing surplus volatility and narrowing the range of outcomes. I think when you're thinking about putting together an LDI program, we've touched on all of these concepts, but it's really the ability to make contributions versus grow, the willingness to make those contributions, and ultimately how sensitive am I from this enterprise organization to this liability on my balance sheet?

Going forward, I guess where I'm getting is, I think there's a lot more people that are aware of the impacts of this liability today than there were a few years ago, particularly with this sharp movement in interest rates. We saw a lot of accelerated contributions in 2017 and 2018 that have gone bye because of this sharp movement, and they didn't hedge, or they didn't think that they were going to. Rates were going higher, why should we hedge now? I'm going to take an interest rate view. I think, in my view, going forward, I think a lot more folks are going to focus on what is the intent or the objective of this plan, and am I good or am I not good at projecting and predicting the direction of interest rates? Because right now, if you're not hedging your interest rate risk implicitly, you're taking a bet on which direction that's going.

I think when you make a contribution to a plan, first and foremost, if you're a plan sponsor, I think you should be making sure that that contribution is meeting its desired objective, and so I think going forward, where I'm going is there's a lot more sensitivity around a lot of these other factors, where historically, I don't know if there was as much focus on some of the outcomes by taking perhaps unintended bets or risks in the portfolio.

David Phillips: I think as pensions go forward, more and more money is going to be allocated to LDIs, a percentage as plans get funded better, and so I think that's going to create an opportunity for people to think a lot more creatively about the way they're investing those assets and how they're going to get to their end goal of paying off the plan once and for all.

I think there are a lot of directions that can turn. I think that transparency is going to be an important part of that, so that the plan sponsors are getting the results that they're expecting to be getting, and so I think there's a ways to go still, rather than just the same formula or recipe we've been using for the last 15 years.

Michael Jarasitis: Yeah, I think LDI is a juicy topic as you said, because it's where every plan sponsor wants to be. I think the last 10 years have been about education in plan sponsors and moving from that I'm just looking at my assets and their return versus I'm thinking about my funded status. I think by and large, a lot of them have got there and they're in that framework now, so now it's going to be more about second order details and some of the issues we've talked today about everyone's piling into the same assets classes, are there concentration risks? How do we deal with that? As plan sponsors move along their glide path, start to target their liabilities more specifically, on the asset management side, how do we scale and deal with having just a huge book of customized accounts?

Jenna Dagenhart: Any final thoughts for you Kevin?

Kevin McLaughlin: You, I would say three things. One is in LDI you're going to see more of the same in some sense. It'll be more LDI and more hedging, and more focus on liabilities. What's different from where we are today and where we've been in the past is many, many more plans are becoming cash flow negative and entering the decumulation phase, so in our view, how you need to think about managing risk and return in the decumulation phase is very different in the accumulation phase. Getting some strategies around that are going to be very important.

The third thing is as more plan sponsors get better funded, they're going to want more holistic solutions that actually deliver the liabilities through time and maybe compete with PRT, so more holistic, more LDI and more appropriate solutions for the decumulation phase going forward.

Jenna Dagenhart: Well gentlemen, thank you so much for joining me today. You are a lively bunch and I really appreciate all the analogies and anecdotes, so thank you very much.

Kevin McLaughlin: It's been good.

Brett Cornwell: Our pleasure., thanks for having us.

Jenna Dagenhart: Thank you for watching. I was joined by Kevin McLaughlin, Head of Liability Risk Management at Insight Investment, Mike Jarasitis, Institutional Portfolio Manager and LDI Strategist at Fidelity Investments, David Phillips, Director of Liability Driven Investment Strategies at Parametric Portfolio Associates, and Brett Cornwell, Fixed Income Client Portfolio Manager at Voya Investment Management. From our studio in New York, I'm Jenna Dagenhart with Asset TV.