Liabilitydriven investment strategies focus on meeting obligations from "summary" of Institutional Investment Management by Frank J. Fabozzi
Liability-driven investment strategies are designed to ensure that an institution can meet its obligations in the future. These strategies recognize that the primary goal of an institutional investor is not simply to achieve the highest possible return on investment, but rather to generate returns that are sufficient to fulfill its commitments. By focusing on meeting obligations, institutional investors can better manage risk and uncertainty in their portfolios. The key idea behind liability-driven investment strategies is to align the assets of the institution with its liabilities. This involves taking into account the timing and amount of future payments that the institution is obligated to make, such as pension payments or insurance claims. By matching the duration and cash flow characteristics of assets with liabilities, an institution can reduce the risk of being unable to meet its obligations when they come due. In practice, liability-driven investment strategies may involve investing in fixed-income securities that have similar cash flow patterns to the institution's liabilities. This can help ensure that the institution has the necessary funds available when needed, even if the returns on these investments are lower than those of riskier assets. By focusing on cash flow rather than total return, institutional investors can better manage liquidity risk and avoid having to sell assets at inopportune times. Another important aspect of liability-driven investment strategies is the use of liability-driven benchmarks. These benchmarks are based on the institution's specific liabilities and provide a more meaningful measure of investment performance than traditional benchmarks like stock market indices. By comparing investment returns to the performance of liabilities, institutional investors can better assess whether their portfolios are on track to meet their obligations.- Liability-driven investment strategies are a prudent approach for institutional investors seeking to manage risk and uncertainty in their portfolios. By focusing on meeting obligations rather than chasing high returns, these strategies can help ensure the long-term financial health and stability of the institution.
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