Question 3 You are reviewing a UK defined benefit pension fund providing pensions to employees of a large, mature UK company. The scheme has just been closed to new entrants. The scheme is now fully funded after the company made a major one-off contribution to the pension fund in 2020. The asset allocation of the fund is shown in Table 3. Table 3 Asset Allocation 25% 30% 15% 5% UK equities Overseas equities UK fixed income Overseas fixed income UK index-linked bonds Hedge funds Cash 10% 15% 0% (a) Explain the main advantage and three disadvantages of moving to using a Liability Driven Investment (LDI) strategy for the fund. (24 marks) (b) Identify and explain four changes that are likely to be required to the asset allocation that will result from moving to an LDI strategy. Explain the reason why each of these changes will be made and, where appropriate, how derivatives can be used to implement these changes. (40 marks) (c) LDI is considered a form of passive investing, explain why this is the case. (8 marks) (d) LDI is a type of solutions-driven investment strategy. Explain what solutions-driven' means. (12 marks) (e) A fund management company is considering whether to start a new division to offer LDI products to defined benefit pension funds. Discuss whether this would be an attractive new business for the company to move into. (16 marks) Question 3 You are reviewing a UK defined benefit pension fund providing pensions to employees of a large, mature UK company. The scheme has just been closed to new entrants. The scheme is now fully funded after the company made a major one-off contribution to the pension fund in 2020. The asset allocation of the fund is shown in Table 3. Table 3 Asset Allocation 25% 30% 15% 5% UK equities Overseas equities UK fixed income Overseas fixed income UK index-linked bonds Hedge funds Cash 10% 15% 0% (a) Explain the main advantage and three disadvantages of moving to using a Liability Driven Investment (LDI) strategy for the fund. (24 marks) (b) Identify and explain four changes that are likely to be required to the asset allocation that will result from moving to an LDI strategy. Explain the reason why each of these changes will be made and, where appropriate, how derivatives can be used to implement these changes. (40 marks) (c) LDI is considered a form of passive investing, explain why this is the case. (8 marks) (d) LDI is a type of solutions-driven investment strategy. Explain what solutions-driven' means. (12 marks) (e) A fund management company is considering whether to start a new division to offer LDI products to defined benefit pension funds. Discuss whether this would be an attractive new business for the company to move into. (16 marks)
