LDI principles essential for drawdown

The principles of liability driven investment, where the assets are matched to future liabilities (or goals) is in our opinion at No Monkey Business, essential for effective risk management. Diversification of drawdown portfolios across multiple asset classes with the optimistic goal of 'smoothed returns'(due to low correlations) has been only moderately successful. It has highlighted that Diversification is not the appropriate risk management tool. Rather, the LDI approach of matching appropriate assets to known liabilities is far more effective. A typical challenge presented to us is that of a retiree looking to maximise lifetime spending subject to the constraint of not exhausting the capital before the planned duration of the plan is complete. By quantifying the likely range of outcomes with the client, at different levels of risk taking, they are encouraged to make decisions that frame the investment manager's mandate - the target(s), duration, agreed level of risk taking. This explicit approach not only helps the manager but also the client. And it also tends to move the conversation away from a woolly concepts to real valued outcomes which the clients truly understand. EDHEC prepared a paper on this subject titled Asset-Liability Management in Private Wealth Management which is well worth reading.

Posted by: Joe Clark