UK - UK pension funds are increasingly looking into liability hedging structures, despite the collapse of several banks acting as counterparty, according to Mark Davies, investment director at P-Solve.
Davies told IPE today looking only at the past week - which was marked by rallying stock markets worldwide - he has seen significant interest from pension funds wanting to review their strategies and reduce the liability risk.
According to Davies, who has seen a steady grow in the uptake of the strategies over the last five years, pension funds have not been deterred by the recent collapse of Lehman Brothers or other banks which have acted as counterparties.
Liability hedging usually means the use of bonds, interest rates and inflation swaps to reduce the liability risk.
The pension fund exchanges assets with the counterparty as the swaps used change in value and the scheme will hold an asset that will aim to have a value equal to the loss of the swap if the counterparty disappeared.
Davis explained, depending on the documentation, when a counterparty defaults, the pension fund can serve a notice terminating the swaps, which are then immediately worth zero.
"But you are holding collateral, so you are able to place a swap with another counterparty, which can be done in a day," said Davies.
He added: "The risk that you are exposed to when a counterparty defaults is at worst - when you are fully prepared - a one-day move in the underlying liability of the pension scheme, a one-day move in what the swap could have done."
P-Solve, Punter Southall's investment advisory, is pushing itself forward as a one-stop-shop for investment advice in manager selection and transitions, while at the same time also providing the design, implementation and management of derivative based risk management strategies.
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