Indexing Strategies in Liability-Driven Investment

As fixed income managers increasingly focus on aligning their portfolios with specific liability profiles, liability-driven investment (LDI) strategies have gained traction. One popular approach within this framework is indexing, which aims to replicate the performance of a market index rather than actively managing a portfolio.

Consider a pension fund that has future liabilities, such as pension payments, that are highly predictable in terms of timing and amount. Explain how indexing can be utilized in this context to achieve better alignment with the fund’s liabilities. Discuss the advantages of using an indexed strategy over an actively managed strategy in the context of LDI.

Additionally, highlight potential risks associated with employing an indexed approach in LDI management.