02 Jan 2024 3 min read

DB schemes: Is credit the answer?

By Will Riley , Anne-Marie Morris (née Cunnold)

Whether the target is buyout, low-risk self-sufficiency or surplus generation through run-off, we believe credit has an important role to play as schemes focus on their endgame.


The following is an extract from our latest CIO outlook.

In an audience poll at LGIM’s client conference in October, 22% of defined benefit (DB) clients said they had a well-funded buyout surplus, with a further 45% saying they had reached full funding or soon would.[1] Given the significantly improved funding levels, we’ve observed schemes changing their investment strategy and we expect this focus on their endgame to persist in 2024.

DB scheme action points:

  • Capture interest rate market opportunities
  • Consider appropriate credit exposure
  • Prepare portfolios for endgame, whether run-off strategy or buyout

Case study March 2023: British Steel Pension Scheme, working in partnership with LGIM, achieved a £7.5 billion full scheme in the UK to have fully insured all its members benefits.[2]

Peak rates?

In our 2023 CIO outlook, Sonja noted the lack of clarity around peak inflation and peak rates. A year on, yields were back above the peak we saw in the September 2022 gilt market dislocation. We believe the peak of interest rates and the end of the rate-hiking cycle could now be here, as potentially evidenced by the November reversal in rates, with yields falling around 40 basis points in the run-up to the Autumn Statement.[3]

Perhaps unsurprisingly, we have seen hedge ratios of mandates managed by LGIM rise throughout 2023 as schemes take advantage of the higher level of interest rates and opt to ‘lock in’ their funding level gains. This trend has accelerated recently, with schemes wanting to avoid missing this potentially attractive opportunity, and we believe this may continue in early 2024.


A new metric: the credit spread hedge ratio

The industry has historically considered investing in credit as appropriate for self-sufficiency-focused schemes. Additionally, well-funded schemes usually have a high hedge ratio when focusing on buyout-liability basis, but often lack credit exposure compared to an insurer’s cashflow-matched strategy. The Purple Book shows that the average corporate bond allocation for pension schemes was 22% as of 31 March 2022, which is much lower than the expected insurer allocation of around 50% of total interest rate exposure, depending on scheme duration and changing market conditions.


Consequently, many schemes have been increasing their credit exposure to focus on their endgame and this may well develop further through 2024. In doing so they may monitor and even add mandate objectives to target an additional 'de-risking metric' – their credit spread hedge ratio – by investing in physical credit and/or utilising leveraged credit e.g. index credit derivative swaps transacted quickly with typically low transaction costs.

Preparing portfolios for run-off or buyout

Given LGIM’s long history managing self-sufficient insurance mandates, it’s no surprise we’re now also managing pension scheme mandates with specific run-off targets; e.g. returns of liabilities plus a spread using traditional credit, alongside private credit, emerging market debt and high yield.

Similarly, as schemes approach buyout, we’ve been using our experience managing and transitioning assets to insurance companies to help identify which assets can be transferred in-specie and what restructuring opportunities exist on a scheme’s balance sheet to seek to improve the buyout price. Examples range from simple changes such as maturity of instruments within LDI mandates and Solvency II Matching Adjustment eligibility criteria for credit mandates, to innovative solutions to manage illiquid holdings.

As such, over 2024 we expect more schemes to prepare their portfolios for their bespoke endgame.

The above is an extract from our latest CIO outlook.


[1] Also illustrated by Pension Protection Fund data and the Pensions Regulator’s latest Annual Funding Statement

[2] Case study shown for illustrative purposes only. The above information does not constitute a recommendation to buy or sell any security

[3] 30-year nominal yield fall between 31 October 2023 and 22 November 2023

Will Riley

Head of Solutions

Will joined LGIM in January 2019 as Head of Solutions responsible for the strategy and portfolio management of investment solutions for pension schemes and insurance companies. Prior to joining LGIM, Will was head of portfolio management for Client Solutions at BlackRock joining Barclays Global Investors in 2005. His experience includes managing LDI Portfolios, fiduciary management portfolios, multi-asset portfolios and derivative overlay strategies. Prior to joining BlackRock, he was a senior fund manager at Sanlam Investment Management in Cape Town, where he was responsible for asset-liability management of annuity portfolios.

Will Riley

Anne-Marie Morris (née Cunnold)

Head of DB Solutions Strategy

Anne-Marie leads the team responsible for the strategy of objective-driven investment solutions, principally for Defined Benefit Pension Scheme clients. In partnership with the Solutions Portfolio Management team, her team structures and delivers strategies across LGIM’s derivative overlay, LDI and CDI strategies including Buy and Maintain credit. Anne-Marie joined LGIM in 2012, bringing industry experience from prior roles including investment strategy at BlackRock and senior fund manager in structured investments and solutions at Close Brothers Asset Management. Anne-Marie is a CFA charterholder, holds the Financial Derivatives paper from the CISI diploma and graduated from Cambridge University with a first class honours degree in Natural Sciences (theoretical physics). When not eulogising about derivatives and LDI, Anne-Marie might be found exploring historic buildings with her two boys.

Anne-Marie Morris (née Cunnold)