Lane Clark & Peacock develops equity-linked bonds as an alternative to liability-driven investment (14/01/2010)

Lane Clark & Peacock (LCP), a leading firm of investment consultants and actuaries, has devised a new investment approach for pensions schemes that it believes will prove popular as a potentially more practical alternative to liability-driven investment (LDI).

The strategy involves investing in gilts to match liabilities and in equity futures to maintain exposure to assets with higher expected returns. An attractive feature of equity futures is that they do not require full funding upfront, i.e. £100 of equity futures exposure requires much less than £100 of outlay, and sometimes as little as £25. As a result, the remainder can be invested in matching assets, i.e. fixed and index-linked gilts. LCP refers to this type of investment as an “equity-linked bond”.

The key feature of an equity-linked bond is its relative simplicity: it uses well-established techniques and instruments. There are relatively few restrictions on the use of such investments, which means that schemes of all sizes should be able to implement this strategy.

Gavin Orpin, LCP’s Head of Trustee Investment Consulting, said: “Equity-linked bond investments can be used to reduce pension scheme investment risk while retaining outperformance potential. The approach retains many of the positive aspects of the LDI strategy, but is simpler and may be more cost-effective in current markets than a swaps-based solution.”

Orpin added: “Concern about rising pension scheme deficits has never been higher, which is why several clients have been implementing this strategy, which typically outperforms equity markets when liability values are increasing.”