Why strong LDI governance still matters

As defined benefit (DB) scheme funding has improved, many trustees have shifted from growth assets into Liability Driven Investments (LDI) to hedge inflation and interest rate risk. But the gilt crisis of autumn 2022 served as a stark reminder: a well-designed LDI strategy is only as good as the governance behind it.

If your scheme has increased its exposure to LDI, now’s the time to review how it’s governed. That means taking a hard look at structure, collateral processes, and manager oversight.

Structuring your LDI portfolio

The first governance decision is structural: how best to implement your hedge. There’s no one-size-fits-all answer, but three core options dominate:

Pooled funds

These are commonly used by smaller schemes (under £150m) and offer a straightforward route into leveraged LDI. Trustees gain exposure via multi-client vehicles, with options such as:

• Profile funds (mimicking a typical scheme’s liabilities);
• Bucket funds (grouped by maturity); or
• Single gilt funds (targeting individual gilts).

They’re cost-effective but come with limitations – most notably, less flexibility and the risk of exposure being reduced even if your scheme has sufficient collateral.

Segregated mandates

For schemes over around £150m, segregated arrangements can offer a better fit. These give trustees direct ownership of the instruments – gilts, swaps, repurchase agreements – and allow for bespoke hedging, tailored benchmarks, and more flexible collateral management. The trade-off? More governance effort, greater legal exposure, and the need for a custodian.

Bespoke pooled funds

This hybrid model blends pooled execution with a bespoke design. The scheme is the sole investor, which means greater flexibility (similar to segregated) but without direct asset ownership. These can be attractive for schemes that want to avoid some of the governance of segregated mandates but may involve higher setup and ongoing costs.

Comparing the options

While segregated mandates generally offer the best flexibility for larger schemes, trustees need to weigh that against cost, complexity, and governance capacity.

Collateral: The hidden pillar of LDI

The 2022 crisis exposed how critical it is to hold – and manage – collateral correctly. Under any structure, schemes must meet yield stress requirements to avoid forced unwinds during periods of volatility.

What regulators expect

• Bank of England (BoE): Portfolios must be able to tolerate a 2.5% rise in gilt yields over five days, calculated as a 1.7% market shock plus a 0.8% operational buffer.
• Central Bank of Ireland / CSSF: maintain a minimum tolerance of 3% at all times within pooled funds, with expectations of 3-4% in practice.
• The Pensions Regulator (TPR): Aligns with BoE; also stresses the importance of regular testing and monitoring.

Our recommendation

LDI managers should be able to automatically recapitalise funds after a 1.7% shock as an absolute minimum, using pre-agreed collateral arrangements, i.e. with no trustee intervention required. However, we typically advise clients to hold much more prudent levels of capital, for example:

This structure ensures resilience and reduces operational risk during market stress.

Choosing the right manager

With LDI often the largest allocation in a DB scheme, manager selection isn’t just about performance – it’s about execution quality, operational risk, and long-term partnership.

We rate LDI managers based on 10 core factors, including counterparty risk, modelling capabilities, and client service. Each manager receives one of three designations:

1. High conviction: We have strong confidence in all areas.
2. Acceptable: Some minor concerns, but broadly capable.
3. Low conviction: Material concerns in one or more key areas.

Manager ratings overview:

These ratings are updated at least quarterly and offer trustees an evidence-based framework for selecting or reviewing LDI managers.

Making governance simpler

We recognise that LDI governance can be resource-intensive – particularly for schemes without in-house investment teams. That’s why we’ve developed two governance-friendly models:

Streamlined

Ideal for schemes under £100m, Streamlined investment consulting gives access to LGIM’s investment platform with institutional pricing and pre-built portfolios.

Select

For schemes between £100m and £1bn, our Select investment consulting service gives access to Insight Investment LDI (under pooled or segregated mandates) within a wrapped arrangement via Northern Trust. Trustees benefit from delegated collateral arrangements, solutions managed to liability benchmarks, a curated manager panel, and greater collateral flexibility through delegated authority.

Need help reviewing your LDI setup?

We can support scheme-specific reviews of structure, manager selection, and collateral resilience. For more information, contact Danielle Markham or Luke Wheeler.