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IPE special report May 2018

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Pension fund hedging rises to highest level in a decade

The annual volume of hedging activity undertaken by UK pension schemes and other institutional investors grew to the highest level seen in nearly a decade last year, according to BMO Global Asset Management.

The investment management firm said its latest quarterly liability driven investment (LDI) survey revealed that hedging volumes were at their highest level since the firm started conducting the surveys nine years ago. This indicated that more schemes were getting rid of liability risk altogether.

Though hedging levels were consistently high throughout last year compared to other years, both interest rate and inflation hedging had fallen slightly in the last quarter of the year, BMO said.

Total interest rate liability hedging activity shrank by 6% to £27.9bn (€32.9bn) during the quarter, and inflation hedging fell 7% to £23.9bn the firm said.

The firm said the fall in overall interest rate and inflation hedging was unusual because there tended to be significant new activity in the fourth quarter of the year as schemes reassessed their policies before the year’s end.

Rosa Fenwick, LDI portfolio manager at BMO Global Asset Management, said: “2016 was a year that saw both a greater peak-to-trough move in 30-year gilt yields than in 2008 and the greatest annual volume of hedging activity since our survey began.”

She said this pointed to a “shifting paradigm” within the hedging mentality of the LDI marketplace.

“More pension schemes are taking liability risk off the table and adopting both a systematic hedging approach to increase outright hedging levels and a dynamic hedging strategy that makes the most of short-lived market events,” she said.

“Looking to 2017, the de-risking theme is likely to continue as funding ratios improve,” Fenwick added.

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