How do I construct the return-seeking portfolio to complement the LDI sleeve?

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AcadiFi · Accepted Answer

The return-seeking (RS) portfolio's job is to generate excess return above the liability growth rate (roughly the discount rate plus service cost) to close funding gaps or pre-fund future growth. Because the LDI sleeve handles rate and inflation risk, the RS sleeve can focus purely on equity and alternative risk premia without worrying about duration or inflation matching. Construction framework. First, set the RS target return. If liability grows 5.5% per year and LDI sleeve earns 4.2%, the RS sleeve on 40% of assets must earn (5.5% - 4.2% x 0.6) / 0.4 = 7.45% to keep up. Second, diversify broadly. A typical RS mix: 40% global developed equity, 15% emerging markets, 15% private equity, 10% private credit, 10% infrastructure/real estate, 10% hedge funds or absolute return. Third, consider liquidity. RS allocations to illiquids (PE, infra, private credit) can be 30-50% if the plan has strong cash flow stability but should be lower if the plan is mature with net cash outflows. For Dunbarton Sterling Pension (mature plan, 45% active), private market allocation is capped at 25% to preserve liquidity for benefit payments. Fourth, overlay considerations. Currency hedging for international equity (50-100% hedge typical). Tail risk hedges like equity puts during elevated vol regimes. Fifth, evaluate correlations with liability — avoid assets that move adversely when liability rises (e.g., long-duration credit has some rate sensitivity that LDI already covers). RS should be rate-neutral on average.

How do I construct the return-seeking portfolio to complement the LDI sleeve?

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