Application of Leverage in Liability-Driven Investing
The Liability-Driven Investing (LDI) framework describes a pension investment strategy that targets future liabilities with dedicated cash-flow generation components. LDI uses a technique called the “dedicated portfolio” as specific investments, mostly long-duration fixed-income (FI) assets, are designated to match specific future liabilities.
The duration of the assets should ideally be identical to the duration of the liabilities, so that fluctuations in interest rates will have equal and offsetting effects on both the assets and the liabilities. In this regard, the liabilities are matched by the dedicated assets.
This technique is also known as “asset-liability management.” Another term, “portfolio immunization,” follows the same logic but describes a more precise matching between assets and liabilities under ideal conditions, a status most LDI investments cannot achieve as liability cash flows are hard to know with certainty.