Liability-driven investment is a half trillion pound business in the UK, but the market is dominated by three big players. Could a second-tier provider upset this balance? George Mitton reports.
Few would have believed that, 10 years ago, liability-driven investment (LDI) would represent probably the biggest exposure UK pension schemes have to anything other than equities.
The value of liabilities hedged by LDI in the UK were £446 billion (€506 billion) in 2012, according to a survey by consultancy KPMG, a remarkable figure given that the first LDI mandates in the country were only awarded in the mid-2000s.
Yet the spoils of this new service have not been shared equally. The UK market is split between three providers: BlackRock, which acquired Barclays Global Investors, generally considered the first to market; Insight Investment, an asset manager that has carved out a profitable niche in LDI; and Legal & General Investment Management, the third to the market but now the biggest, according to the survey, with 43% of UK liabilities hedged.
Between them, they control more than 90% of the market for LDI in the country, by liabilities.
But they are not the only ones to offer LDI services. There are a raft of second-tier players such as Cardano, F&C Asset Management and Schroders offering innovative services, but so far, they have been unable to end the dominance of the big three. What hope does the second tier have of dislodging the top players?
Events in the LDI market are important for the asset management industry because it’s big business. The survey counted 686 LDI mandates in the UK in 2012, and found that the market had grown 11% since the previous year in terms of liabilities hedged.
The market could grow a lot more. Only 10% of about 7,000 defined benefit pension schemes have taken on LDI mandates. The remaining pension schemes command about three-quarters of liabilities in the UK. However, consultants say the top players are in a strong position because they are already established.
“The three big players win a lot of business just because they’re big,” says Barry Jones, executive consultant at KPMG. “The other guys have got good teams and good offerings, but trustees often decide to follow the herd.”
This is frustrating for the second-tier players, says Jones. Losing out on mandates is costly, because LDI requires a heavy investment from providers.
“For the second-tier guys, they’ve had to beef up their teams to give them credibility, because LDI is a labour-intensive role, and they probably don’t have the assets or liabilities under management to make it massively profitable,” he says.
But it is possible for a second-tier player to make inroads into the market. Julian Lyne, head of global consultants and UK institutional, F&C Asset Management, says his company managed to increase its LDI client mandates in the UK by 70% between 2011 and 2012, which led to a 50% increase in liabilities hedged. The firm’s growth outstripped the UK market’s growth of 11% in the same period, says the survey.
Lyne says a substantial number of client wins were from pension schemes that were dissatisfied with their existing LDI provider.
“There was the assumption that LDI mandates would be put in place and then forgotten. That’s not the case, we are winning business as pension schemes implement LDI strategies for the first time and also business wins when they’re changing managers for a number of reasons. Service is one.”
Lyne says a lot of the growth was in pooled funds, which are often more suitable for smaller pension funds. In a pooled fund, liabilities from several different clients are combined, unlike in a segregated mandate. The survey found that the big three only control 61% of the market for pooled funds.
However, pooled funds – including “bespoke” pooled funds – represent a mere 15% of the total LDI market in the UK, according to the survey.
Lyne says he hopes F&C can distinguish its offering from the big players by nurturing close links with trustees and consultants. “We are pitching and winning business in the UK LDI space on a regular basis. There are a number of providers and, while historically, some have had a bigger book, the UK market is not a three-horse race.”
Consultants say there are good reasons to think the second-tier players can capture market share in future. First, because the teams are smaller, they can be quicker to market with new services and better at adapting to new trends. Second-tier players have a better chance of winning mandates from smaller pension schemes than big ones, and the majority of the UK schemes that have yet to implement LDI are small.
As the market becomes more sophisticated, there are greater opportunities for second-tier players to distinguish themselves with innovative services.
However, investment managers at the big three argue that even with these advantages for the second tier, the majority of the LDI business in the UK will continue to flow to them.
“It still takes a big machine to operate a business such as LDI,” says Simon Wilkinson, head of LDI funds team, Legal & General Investment Management. “Let’s say a niche player becomes expert at using option products. They will still need all the pricing tools, risk tools and resources that the big guys have; front office expertise, people in the middle office to source the data, valuation models, and independent oversight of risk.”
Wilkinson concedes that second-tier players can create innovative LDI services, but he suggests pension schemes and investment consultants would rather go to one of the big three and ask them to replicate that service than trust their money to a second-tier player. Plus, the large player always has the option simply to poach the staff at the second-tier player who came up with the new service.
“The consultants might come to us three and say, ‘Why don’t you hire those guys? If they were sitting in your place, we’d be so much more comfortable. Your independent risk team would be looking at what they’re doing, they’d have all your systems, downstream processes – we’d rather give it to you.”
Clearly, the big three are not about to relinquish their control of the market, and as Williamson says, they have many tools at their disposal to help maintain their lead. However, the top players are aware of the challenge posed by their upstart rivals in the UK.
“It would be naive to dismiss the competitive threat from new entrants,” says Serkan Bektas, co-head of solution design, financial solutions group, Insight Investment. “There is concentration in the market, but whenever we go into a new pitch, it doesn’t feel that way.
“There is considerable pressure on pricing and offering terms, because the consultants are well aware of capabilities and they make sure the competitive tension is there.”
©2013 funds europe