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BT scheme sees interest rate hedge lower returns by £750m

UK - Investment returns at the BT Pension Scheme (BTPS) shrank to 1.7% last year, as an ill-fated attempt to hedge against rising interest rates caused the scheme to underperform its overall benchmark by two percentage points.

The 2011 investment return compares with 2010’s 11.8% and the 12.2% achieved in 2009.

A tactical investment strategy implemented by the BTPS trustee in late 2010 to shelter the scheme from increases in long-term interest rates resulted in a 2.1%, or £758m (€968m), reduction in pension scheme returns, as it sold UK government bonds and hedged its domestic corporate bond exposure.

The rationale for the strategy had been based on the fact that interest rates were at a 250-year low while the global economy appeared to be recovering. This seemed to present a significant risk of rising rates and falling bond prices, the scheme noted.

In the event, however, investors fled towards the safety of gilts in 2011 causing interest rates to fall.

This unfortunate strategy was the main reason for the underperformance relative to the benchmark return of 3.7%, the scheme said, adding that the strategy was abandoned in 2012.

Equities performed poorly for the scheme in 2011, with returns for the asset class detracting 2.5% from overall performance.

“This was offset by the strong returns in fixed income and inflation linked which added 5.9%,” it said.

“Property added a further 0.8% to the total return whilst alternatives were slightly down, taking away a further 0.3%,” the report said.

However, within the asset classes, individual managers had performed well, it said, with equity managers adding £109m by beating their benchmarks, alternatives managers adding £73m and fixed income managers adding £19m.

A move to tactically underweight equities in the second half of 2011 added 0.2% or £80m to the scheme, according to the report.

Regarding the market outlook, the BT scheme said there were some reasons to believe investors’ fears may not be realised. It cited signs of falling unemployment and sustainable growth in the US, Chinese monetary easing and the European Central Bank’s emergency measures to provide longer-term funding for banks.

The total value of the fund fell to £36.0bn at the end of 2011 from £36.7bn the year before.

The funding deficit as at June 30, 2011 was finalised at £3.9bn - lower than the £4.1bn provisional figure previously announced, the scheme said.

This meant that the deficit contributions payable by the company from 2015 to 2021 would be amended to £295m a year, down from £325m, while those for 2013 and 2014 would remain unchanged at £325m, it said.

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