I talk about the term “liability-driven investment” (or LDI). It’s been blamed for some trouble in the United Kingdom lately during their interest rate run-up, but no such trouble has occurred in the United States as interest rates have also run up over here. It turns out, LDI is a term that can mean many different things which can differ depending on different jurisdictions and different goals.
Episode Links
Investopedia link: Liability Driven Investment (LDI)
A liability-driven investment, otherwise known as liability-driven investing, is primarily slated toward gaining enough assets to cover all current and future liabilities. This type of investing is common when dealing with defined-benefit pension plans because the liabilities involved quite frequently climb into billions of dollars with the largest of the pension plans.
….There is not one agreed-upon approach or definition for the specific actions taken in regard to the LDI. Pension fund managers quite often use a variety of approaches under the LDI strategy banner. Broadly, however, they have two objectives. The first one is to manage or minimize risk from liabilities. These risks range from a change in interest rates to currency inflation because they have a direct effect on the funding status of the pension plan.2
To do this, the firm might project current liabilities into the future in order to determine a suitable figure for risk. The second objective to generate returns from available assets. At this stage, the firm might seek out equity or debt instruments that generate returns commensurate with its estimated liabilities.2
Hedging is often involved, either in part or in whole, to block or limit the fund’s exposure to inflation and interest rates, as these risks often take a bite out of the fund’s ability to make good on the promises it has made to members.2
In the past, bonds were often used to partially hedge for interest-rate risks, but the LDI strategy tends to focus on using swaps and various other derivatives.3 Whatever approach is used typically pursues a "glide path" that aims to reduce risks—such as interest rates—over time and achieve returns that either match or exceed the growth of anticipated pension plan liabilities.
"I don't know what you mean by 'glory,' " Alice said.
Humpty Dumpty smiled contemptuously. "Of course you don't—till I tell you. I meant 'there's a nice knock-down argument for you!'"
"But 'glory' doesn't mean 'a nice knock-down argument'," Alice objected.
"When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean—neither more nor less."
"The question is," said Alice, "whether you can make words mean so many different things."
"The question is," said Humpty Dumpty, "which is to be master—that's all."
In case you’re interested in Cantor’s Diagonal Argument:
And here is my text version of the argument, which I wrote back in 12 April 2001:
When I presented this argument to a bunch of middle school students, the response I got was "but infinity is infinity" -- making me realize that I should never have used the word infinity to begin with. People have connotations tied up with words like infinity and chaos that have nothing to do with the precise mathematical definitions of the words - often people use words as humpty dumpty does - making them mean what they want them to mean, so that they can use them to express their ideas. However, mathematical ideas are much more limited that the ideas the human mind can hold and words are restricted to very particular uses. "Continuous" means something extremely precise (though not what you think it means. Most people equate continuous with smooth), and "infinity", though it can take on different meanings in mathematical context, has only one meaning in any given mathematical context.
Liability-Driven Investment: Definitions and Jargon