Demystifying Liability-Driven Investment (LDI) Transitions

Written in partnership with Van Lanschot Kempen and State Street Investment Management

Why LDI transitions feel daunting and why they don’t have to be

For many UK DB pension trustees, moving LDI managers can feel like one of the more challenging governance decisions they face. LDI portfolios can be complex, often involving leverage, derivatives, collateral and multiple counterparties.

Recent periods of market stress have understandably heightened trustee sensitivity to liquidity, operational resilience and the consequences of something going wrong.

Against that backdrop, it is entirely reasonable for trustees to feel cautious about changing the engine while the plane is in the air.

In practice, however, LDI transitions are neither unusual nor inherently risky when they are properly planned and governed. Done well, they are structured, project managed exercises, typically led by specialists from the fiduciary manager or consultant, working alongside the relevant LDI managers. They use well-established processes designed to maintain hedge continuity, reduce risk and minimise disruption.

There should be no need for trustees to be closely involved in the mechanics and their governance time is far better spent ensuring the right providers are appointed and that appropriate oversight arrangements are in place. Trustees should also have sufficient access to information and transparency to feel assured that the transition is progressing as planned.

This article aims to demystify how LDI transitions work in practice and to explain the controls that govern them. Drawing on experience from Van Lanschot Kempen, a specialist fiduciary manager, and State Street Investment Management, an LDI manager, we focus on preparation, coordination and governance, rather than market views or product selection.

Key takeaways

• LDI transitions are carefully project-managed exercises, not ad hoc trading events.
• As with all delegated decisions, responsibility for execution should sit with the fiduciary manager and the investment managers, not trustees.
• Early portfolio reviews and operational preparation materially reduce risk later in the process.
• Staging, delayed settlement and liquidity planning are all straightforward tools to minimise risk and prevent out-of-market exposure.
• In-kind transfers and novations are designed to preserve hedge continuity.
• Clear, regular reporting supports trustee confidence and a no-surprises approach to governance.

The transition architecture: project management and governance

Successful LDI transitions depend on clear project ownership and disciplined governance. All transitions have their own subtleties and so there is no one size-fits-all approach. However, the process is one that experienced specialists navigate routinely. In practice, this role of coordination is usually fulfilled by a fiduciary manager or similar, working independently on behalf of the trustees alongside the scheme’s other advisers. The outgoing and incoming LDI managers will agree the timeline, clarify responsibilities and identify key decision points. The aim is to ensure the transition proceeds in a controlled and predictable manner.

Who does what

LDI transitions typically involve a number of different parties, each with a clearly defined role:

• Trustees appoint the relevant parties and hold them to account. They are not expected to be involved in operational detail.
• The fiduciary manager coordinates the transition, manages governance, and acts as the central point of control. Working independently to the LDI managers, they oversee each aspect of execution on behalf of the trustees.
• An oversight consultant, if appointed, provides an additional layer of assurance to the trustees by overseeing elements of the fiduciary manager’s plan.
• The outgoing LDI manager provides portfolio data, valuations and operational support.
• The incoming LDI manager undertakes onboarding, execution and ongoing risk management.
• Custodians, transition managers and legal teams support account set-up, settlement, execution and documentation.

From a trustee perspective, the key message is simple: you should not be expected to orchestrate these interactions yourself. A well designed governance framework allows trustees to focus on outcomes rather than process.

Pre-transition portfolio review: simplify before you move

One of the most important stages of an LDI transition happens before any assets move at all: a detailed review of the existing portfolio.

Over time, LDI portfolios can accumulate complexity. They may include bespoke instruments, small residual positions, or legacy hedges that no longer align neatly with today’s liability profile or operational set up. Left unexamined, features such as these would complicate execution and may increase operational risk during the transition.

A fresh pair of eyes on the portfolio may also identify opportunities to improve efficiency and reduce costs over the longer term. This can help to inform the actions taken through the transition, moving the portfolio to an optimal position, rather than simply transferring the existing exposure from A to B.

A pre-transition review allows these factors to be identified and analysed early. It may make sense to simplify the portfolio before moving, for example by consolidating positions or exiting instruments that add disproportionate complexity. In other cases, retaining the existing positions may be preferable, avoiding unnecessary market impact or cost.

There is no one-size-fits-all answer. The value of the review lies in making deliberate, informed decisions that will help avoid complications mid execution. Experience consistently shows that complexity addressed early is far easier to manage than complexity uncovered at the point of transfer.

Administration and operational readiness: the hidden critical path

While market risk often attracts the most attention, operational readiness is frequently the true critical path in an LDI transition.

Custody and accounts

Where assets are moving to a new custodian, a range of preparatory steps are required. New custody and collateral accounts must be opened, settlement instructions agreed, reporting feeds established and operational processes tested. None of these steps are particularly complex in isolation, but they take time and must be completed before execution can begin.

Identifiers and documentation

Legal Entity Identifiers (LEIs) are required for trading and regulatory reporting, and changes to trading arrangements can trigger updates. Similarly, LDI mandates rely on a suite of trading and collateral documents, including clearing agreements, CSAs (Credit Support Annexes) and GMRAs (Global Master Repurchase Agreements).

These documents are well-understood market standards, but they often involve multiple parties and cannot be completed overnight. Acknowledging the need for documentation and including it early in the transition plan is key to success and avoiding delays.

For trustees, the important point is not the detail of these arrangements, but the fact that they are being actively managed by the fiduciary manager and the investment managers involved.

Transition planning: managing settlement risk and market exposure

Decisions around staging, delayed settlement and liquidity use are sometimes discussed separately, but they share a common objective: eliminating the risk of being “out-of-market” during the transition.

This is particularly important for leveraged LDI positions. Transferring a leveraged position typically involves closing it out at the outgoing manager and reopening an equivalent position on the same terms at the incoming manager, with the process carefully coordinated. During that process, sufficient collateral must be available to support both positions, and settlement cycles need to be carefully coordinated.

Staging and delayed settlement

Staging a transition, or using delayed settlement, can help align the settlement cycles of different assets and derivatives. Rather than attempting to move everything simultaneously, assets can be transitioned in a sequence that maintains hedge ratios and reduces operational strain.

For example, cleared swaps cannot typically be ported until the required initial margin is in place.

One way to manage this is to transfer a tranche of bonds in specie at an earlier stage, allowing them to be pledged as initial margin at the clearing house. This helps ensure that the necessary collateral is in place before the swaps are ported later in the transition.

Delayed settlement can be used to ensure that sufficient collateral, cash and securities are available to support settlement, particularly where leveraged positions are being transferred. By aligning trade settlement with collateral availability at both managers, delayed settlement can help avoid temporary gaps in market exposure as positions are closed and re-opened.

LDI as a source of liquidity

In some cases, the LDI portfolio may also need to provide liquidity to support wider asset allocation changes. When this is planned in advance and governed appropriately, it can be incorporated into the transition without undermining hedge integrity.

This is particularly relevant for schemes that, as part of a transition, are selling assets with longer settlement cycles and replacing the exposure with assets that settle more quickly.

What matters is not the specific tool used, but the discipline around planning collateral flows, sequencing trades, and monitoring exposures throughout the process. LDI portfolios can offer a high degree of flexibility, helping them to support a secure and efficient transition.

Asset mechanics demystified

In-kind transfers

An in-kind transfer involves moving assets from the outgoing manager to the incoming manager without selling and repurchasing them. This approach is commonly used where assets are eligible and operationally straightforward to transfer. Most unleveraged gilt assets moving from one segregated account to another would be expected to be transferred in this way.

From the trustee’s perspective, the process is light touch and low risk. The fiduciary manager, investment managers and custodians handle the mechanics through well-established processes.

The main considerations tend to be eligibility, valuation timing and operational cut-offs, all of which are addressed through advance planning.

Leveraged gilts and derivatives

Leveraged gilt and derivative positions warrant particular care during a transition because of their sensitivity to timing, collateral flows and market movements. Transition planning therefore focuses on maintaining hedge continuity, coordinating the sequencing of trades and settlements, and ensuring that collateral is available in the right place at the right time. The objective is to ensure that the hedging always remains intact.

Leveraged gilt positions are typically treated separately, as they cannot be transferred in-kind. Instead, bonds can be sold and repurchased simultaneously through a common trading broker, with associated repurchase agreement (repo) contracts coordinated so that existing repo arrangements are closed out through the incumbent manager and reopened with the new manager. This allows identical positions to be closed and re-opened without introducing unnecessary costs or risk.

To support this approach, the incoming manager must be operationally ready to trade with the same repo counterparties that exist in the existing portfolio. This is a key part of the planning process.

While these steps are operationally more involved, careful advance preparation and close coordination between the outgoing and incoming managers, brokers and counterparties mean that the transition can be executed seamlessly.

Cleared and bilateral swap novations

A novation is the legal transfer of a derivative contract from one party to another. For cleared swaps, the key consideration is whether the clearing broker changes. Where it does not, novation can be relatively straightforward. Where it does, margin arrangements, including the potential for margin porting, need to be planned carefully.

Bilateral swaps introduce additional variables through the CSA, the document which defines the agreements that sit alongside the swaps, such as eligible collateral and margining conventions. These factors reinforce the importance of early documentation and sequencing, rather than last-minute execution.

Novations are market-standard and straight-forward transition tools, but the art of execution lies in fully understanding each position and identifying potential issues early enough to avoid delays or disruption.

Reporting and oversight: what good looks like

Good reporting and oversight should start with a comprehensive pre-transition report detailing what will be done and when, including estimated costs. Trustees should then expect clear updates on progress, emerging risks, hedge continuity and collateral movements until the transition is completed. The purpose of this reporting is not to overwhelm, but to provide confidence that the transition is proceeding as planned and that any issues are being identified and addressed early.

Transitions are often not executed overnight, which can lead to periods of exposure being managed across two different parties. This is where independent oversight from a specialist is vital. A fiduciary manager or consultant, working on the trustees’ behalf, should have continual access to portfolio data from each party to monitor that the hedge is doing its job throughout the transition period. Lack of visibility is entirely avoidable and can increase risk in the period before the new LDI manager takes complete control.

Good reporting and oversight ultimately underpins a simple principle: no surprises.

Example transition timeline (illustrative)

• Discovery: portfolio review, role clarity
• Documentation: custody, trading, collateral
• Testing: operational dry runs
• Execution: in-kind transfers, novations
• Maintenance: post-transition monitoring

Mini-glossary (jargon buster)

• LEI: Legal Entity Identifier used in trading and regulatory reporting
• CSA: Credit Support Annex governing collateral for bilateral derivatives
• Novation: Legal transfer of a contract from one party to another
• IM: Initial Margin posted against derivatives
• GMRA: Global Master Repurchase Agreement for repo transactions
• In-kind: Asset transfer without selling and repurchasing
• Cleared vs bilateral: Exchange cleared derivatives vs OTC contracts
• Margin porting: Transferring margin with a novated position

Closing: confidence through preparation

Changing an LDI manager does not need to be a leap of faith. When the transition is led by an experienced fiduciary manager, supported by capable LDI managers, and underpinned by clear governance, it becomes a controlled and well-understood process.

For trustees, confidence comes from preparation and from knowing that the right people are in place to manage the detail.