Liability Benchmark Portfolio
A (possibly theoretical) portfolio of assets which moves in the same way as the estimated liabilities of a pension fund to provide an idea of how those liabilities are changing between actuarial valuations.
Context: See least risk portfolio, liability benchmark return, liability driven investment, cashflow matching, dedication, immunisation. The actuaries have been working on a way of explaining to trustees and to plan sponsors, how their liabilities move, as interest rates and inflation expectations change, without having to wait for a three- year actuarial valuation. There is quite a bit of controversy about this: both in terms of whether it’s possible and whether it improves decision-making. The idea is that you could construct a portfolio of conventional and index linked gilts, from which the cash flows are quite similar to your estimates of future payments, which you could value every day. You could then, so the theory goes, ask your fund manager to beat a “liability benchmark” which is the return from this portfolio. The controversies stem from the idea that you don’t know precisely what your future liabilities are, and therefore you might get a false sense of security from looking at this “LBP”. Also, there are those who question the value of estimating very long term liabilities on a daily basis.
There are various different versions of this “matching” – or hedging strategy, so do ask exactly what your actuary or investment consultant means.