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Derivatives market: LDI drives US funds to long-dated swaps

Vincenzo Pelosi explains why pension funds are catching the swaps bug.

A version of this article first appeared in Total Derivatives.

Total Derivatives is the prime source of real-time news and analysis of the global fixed income derivatives markets.

Until recently the three letters LDI meant absolutely nothing to US pension funds. But that could be about to change.

LDI, or liability-driven investment, has become an obsession for those involved in interest rate markets, and is largely responsible for the dramatic reshaping of the term structure of rates in the long end of both the UK and eurozone curves.

Synonymous with huge flows into longer-dated rates products, LDI is an investment concept that has already been enthusiastically embraced by pension fund managers across Europe in what is a natural and necessary response to increased regulatory scrutiny and more stringent accounting rules.

The adoption of LDI has seen pension funds focus more than ever before on understanding and reducing risk – and less on maximizing return. This process has led to an asset allocation shift out of stocks and into debt, as well as a reduction in the duration gap between assets and liabilities through large-scale buying of long-dated bonds and receiving in long-dated swaps.

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