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IPE special report May 2018

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Goldman expects more pension fund hedging

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GLOBAL – Pension funds and insurance companies in the major markets are likely to increase their interest-rate hedging and asset reallocation, according to Goldman Sachs.

“In 2006, we expect increased interest-rate hedging and asset reallocation (away from equities and towards fixed income and other assets) amongst the insurance and pension fund community across the major markets,” the firm said in an economic research note.

The activity would be motivated by three factors: interest-rate “locking” as schemes look to manage their asset portfolios against their liabilities, especially where bond yields are expected to decline. Then there’s regulatory and accounting changes. In addition there’s changes to pension fund risk management such as liability-driven investing.

“Specifically, on the back of these changes, we anticipate significant hedging of long-dated interest rates through the cash and synthetic markets, selling of cash equities and buying of equity volatility,” the note said.

“We expect these shifts to be sizeable, with timing of these flows largely dependent on three factors.” These included: interest rates, regulatory changes such as the FTK in the Netherlands and “exogenous factors” such as increased mergers and acquisitions activity. This would encourage firms to resolve pensions deficits.

“We expect a continued bid for long-dated assets on the back of pension funds hedging interest rates and extending their asset portfolio duration.”

This implied increased purchases of high quality bonds as well as derivative instruments (both nominal and inflation-linked), such as swaps and swaptions.

The overall expected net equity selling across Europe was put at around €250bn

UK funds have to increase the duration of their portfolios, put at around $1.1trn, with European funds, mostly Dutch plans, face a $520bn task.

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