Dutch funds holding back on rate hedge adjustment
Pension funds are increasingly looking into the hedge interest rate risk but will not rush to adjust cover despite record-low rates, Dutch consultants have suggested.
According to Martijn Euverman, actuary and partner at consultancy Sprenkels & Verschuren, a possible reduction of the level of hedging is on top of the agenda of schemes’ boards.
“Hedging against falling interest rates has been a good strategy during the past years, but rates have come down so far that the risk of a further drop is limited now,” he told IPE’s sister publication PensioenPro.
“And with the current low interest levels, solvency requirements for pension funds are lower, allowing them to take more interest risk,” he argued. “Moreover, rising interest rates would have a negative impact on returns.”
However, Edward Krijgsman, investment consultant and team leader at Mercer, noted only a few clients had decided to implement a limited reduction in hedging, and based this on earlier decisions.
“We observe pension funds want to discuss this with their [stakeholders] about risk attitudes as prescribed by the new financial assessment framework (FTK),” he said.
“In addition, while rates are still decreasing, pension funds also seem to be waiting for clarity about the effect of the ECB’s bonds purchasing programme on interest rates.”
In Krijgsman’s opinion, many pension funds are not in the position to reduce their interest hedge anyway.
“If their coverage ratio is low, reducing their hedge would mean increasing the risk for liabilities, unless they reduce risk elsewhere in their portfolio,” he explained.
Mike Pernot, actuary at consultancy Aon Hewitt also found pension funds did not have concrete plans to decrease their interest rate hedge.
“Ten years ago, we thought that an interest level of 3.7% was a historic low, and last year we thought that interest rates couldn’t drop any further,” he said, explaining schemes reluctance.
Pernot said he expected that pension funds first wanted to look at the interest hedge as part of a new asset-liability management study and feasibility check, following the new FTK.
“Moreover, pension funds with a reserve shortfall are only allowed to change their risk profile once, while schemes with a funding shortfall cannot adjust their risk exposure at all,” he added.
The comments of the consultancies came after Dutch pension funds reported record results over 2014, which were mainly boosted by an extensive interest hedge through government bonds and/or interest swaps.
The €17.5bn pension fund for the retailsector (Detailhandel) said it returned 34.3%, with 20.3 percentage points attributable to its full interest hedge.
However, despite this spectacular result, its funding had only increased 8.5 percentage points to 116.7%, as liabilities had also risen significantly in the wake of dropping interest rates.
The industry-wide scheme for private road transport (Vervoer) reported a result of 27.6%, following an interest hedge of 85%. However, its funding rose no more than 1.6 percentage point to 111.5%.
Recently, the €25bn pension fund of ING said that it had made a 32.4% profit last year, largely thanks to a full hedge of its liabilities.