This question was posed at a recent conference where I spoke. It brought snickers from the crowd, but poignantly captures the widespread view that liability-driven investing lacks penetration. You've been hearing about it more now because of new regulatory and accounting rules on funding requirements and how a pension plan's funded status must be shown on the company's balance sheet. These rules (under PPA and FAS 158) may lead to higher volatility of both a plan's funding requirements and the company's financials. LDI can help limit that volatility.

LDI is a strategy that considers a pension plan's liabilities when investing its assets. It frames risk and return relative to the movements of the liabilities. You can still seek higher returns by taking investment risk, even in an LDI strategy.

Because traditional pension liabilities increase when interest rates go down and the value of bonds do the same thing, LDI strategies usually incorporate bonds to control changes in the funded status. To minimize risk, an LDI strategy focuses on finding the right bonds to match the interest-rate sensitivity of the pension liability, matching the duration of the bonds with the liability stream.

With all of the compelling reasons for implementing LDI, why is adoption so slow? There are three probable reasons: inertia, betting on interest rates and peer comparisons. Understanding these counterproductive tendencies and how to overcome them is integral to a plan's success.

The pension investment paradigm traditionally has been chasing returns rather than managing for pension risk, which is driven by changes in a plan's funded status. The new pension rules encourage closer liability matching, so the definition of risk and the efficient frontier has changed. For instance, in the absolute or total return world, cash is the low-risk asset but also the lowest-returning asset on a long-term basis. Equities represent high risk and high return. Intermediate bonds are also a fairly efficient tradeoff between risk and return. Compared to intermediate bonds, long bonds introduce more volatility risk but carry only slightly higher return.

But for most traditional open plans, all that changes when considering the liability stream, which basically acts like a long bond. As rates rise, both the value of the liability and long bond drops; when rates fall, their values rise. Therefore, in the liability-efficient world, the least risky asset is not cash, but a long bond.

This shift from the absolute-return world to the liability-efficient world has not widely occurred. The new rules mean those strategies can have a big impact on company financials and funding requirements. Do you want to live with that level of uncertainty in this environment? PQ Corporation didn't. The Valley Forge, Penn.-based producer of performance materials moved to an LDI strategy about two years ago. "We had a strong understanding of the new rules and what they meant to our business, so moderating the volatility of our funded status was important to us," says Susan Olafson, PQ's director of benefits, compensation and HRIS. After initially implementing an extended duration strategy and then moving to long-term corporates, the dynamic nature of the approach paid off, she said. "Most important, substantially lengthening the duration of our bond portfolio allowed our asset values to move more closely in line with the value of our pension liability."

Because interest rates seem low, many investment committees are leery of matching liabilities with long-dated bonds. They argue that rates ought to rise, which would mean a drop in bond prices. But as we know, betting on the direction of interest rates is a difficult proposition, especially given a pension plan's rate sensitivity and the difficulty of oversight by part-time investment committees.

If a committee views current rates as low, a process that gradually invests in better matching bonds can move the portfolio toward risk control with less concern about market timing. Do you want to assume responsibility for maintaining a shorter bond position as a tactical bet?

For years, consultants and others have cautioned sponsors against gauging their plans against peer plans on performance and asset mix. Peer comparison also creates a chicken-or-egg dilemma: Few will implement LDI because few are doing it.

Sticking close to what your peers are doing may be a mistake for a host of reasons: their liability, plan size, plan status (i.e., open or frozen), financial and business situation (i.e., cash flow, dependence on market cyclicality, and ownership structure) and corporate risk preference could be wholly different than yours. It makes sense to do what is best for the plan and your client's unique circumstances.

Marcia Peters, director of risk management at consulting firm Portfolio Evaluations, also cautions against comparing one plan to those of a peer group. Instead, she says, focus more on a customized benchmark created to reflect that plan's unique asset mix and change in asset-to-liability valuation. This trio can be a powerful barrier to changing a portfolio. But action is needed. The rules and markets have changed and the 1990s aren't coming back.

Here are some logical steps for moving toward an LDI framework:

>> Move from an absolute-return world to a liability-efficient world. Because the funding ratio has become more important than the portfolio's annual return, you need to look at risk differently.

>> Avoid market-timing. Gradual adoption of LDI is usually recommended - market-timing is rarely advisable and moving gradually will minimize the risk of a decision that looks bad in hindsight.

>> Refrain from comparing a client's approach to those of its peers. The overriding factors in investment decisions should be the characteristics of the plan and the company - not what other plan sponsors are doing.

It's probably safe to say that with the market turmoil of 2008-2009, plan sponsors and investment committees want to avoid more surprises. While higher levels of risk may help improve current underfunded ratios, an understanding of LDI will help preserve future higher funded ratios. It's likely that the perceived risk of moving to an LDI strategy is far lower than other strategies. Looking at LDI through a different lens may be all you need to get started.