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AXA backs derivatives for pension funds

GLOBAL – AXA Investment Managers has backed a recent academic study which suggested that pension funds should consider using derivatives.

“Matching liabilities using conventional assets is sometimes just not achievable where pension liabilities routinely extend beyond 40 years,” said AXA product specialist Vincent De Martel.

He says pension funds with a large allocation to bonds should consider derivative products known as interest rate swaps – where borrowers switch floating-rate loans for fixed rate loans in another country.

“In our view any scheme with over 30% in bonds should consider the use of interest rate swaps, in order to address mismatch risks," said De Martel.

"The function of derivatives is to reshape the risk/return profile of an asset; in other words, they take the returns of an asset and modify them in a way which is suitable for the investor.”

“As such, they can be used by pension schemes, in order to adapt the returns of equities and bonds to match the liabilities of the scheme.” De Martel likens the process to taking raw spaghetti and “cooking it so that you can turn it into the shape you want”.

He expects that interest-rate volatility will be a cause for concern for pension funds and plan sponsors under the FRS17 accounting standard, which takes a market value of assets and liabilities.

He notes that more than 90% of the world's top 500 companies use derivative instruments to manage and hedge their risks more effectively.

The comments follow a study by Cardano Risk Management and City University in London. The paper found that properly constructed options strategies could add substantial value to pension fund management.

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