Liability Driven Investing (LDI) could gain a boost through ARPs

Many pension funds that engage in liability driven investing (LDI) use the Bloomberg Barclay US Long Government/Credit Index as a benchmark, (LGC). This index is comprised of just over 40% in long government bonds and the remainder in credit sensitive bonds. To beat the index generally requires pensions to hold more corporate debt, especially lower rated bonds. 

Pensions that try and match the benchmark are taking risk in one dimension, credit exposure. We suggest that there are simple ways to diversify LDI matched portfolio while still gain the advantage of long duration instruments.

Pensions can use alternative risk premia as an overlay on a long Treasury bond portfolio. The investor will get the long duration exposure from the Treasuries while gaining return from the risk premia. However, instead of getting taking on risk in the form of credit carry through corporate debt, the pension can diversify into other risk premia. This type of overlay alternative is especially useful when credit spreads are tight. Since credit spreads can be replicated through equity and bond exposure,  the overlay can be  structured to hold similar but cheaper risk exposures. The overlay also can be structured to provide higher stand-alone return or returns that are less correlated with the credit cycle. In either case, this can reduce the pension's cost of liability matching.