This month's Off The Record survey looks at pension fund liability hedging. Some 20% of funds responding to the survey had a current level of hedging relative to liabilities of over 100%, the highest being 115%. Over 25% of respondents had a level of 50-99%, while 29% gave their level as being between 1-49%. A total of 8 respondents (26%) stated the fund's current level is 0%.
Just over half of respondents plan to maintain their current hedge ratio, with around 40% planning an increase and 10% planning to decrease it. The majority (56.5%) stated that their reason for either maintaining, increasing or decreasing the current hedge ratio is the belief that it contributes to effective scheme risk management. Only one respondent said their plan, which is to maintain the ratio, was due to accounting standards, and just 9.5% said their reason was a result of pressure from the national regulator/supervisor. The remaining 31.5% had varying reasons for their decisions, with one Dutch fund planning to maintain its 0% ratio as "hedging costs money and [the fund] can take the risk".
Interest rate swaps were the most frequent method of implementing liability hedging among respondents, with 60.5% using them. This was closely followed by cash market sovereign nominal bonds, cash market inflation-linked bonds and cash market corporate bonds, each of which were used by 54% of respondents. Inflation swaps were used by 39.5%, while bond futures, swaptions and pooled LDI vehicles were each used by 14.5%. Just under 11% of respondents said they used repo-funded bond positions or longevity-related instruments.
For some respondents there had been no real change in the instruments their fund uses over the last 18 months, but several had made significant adjustments. One Dutch fund said it had "sold swaptions and all non-core euro bonds, [and] bought Dutch, French and German government bonds. This is due to the change in the yield curve used to calculate the liabilities". However, another said the fund had "sold long term government bonds, and bought corporate bonds and interest rate swaps".
Some 27.5% of respondents said they would maintain their level of hedge as interest rates rise, while 14% said they would increase levels. Just over 17% stated they would decrease levels and a further 27.5% said their fund did not deviate from strategy on forecasts of interest rate moves. A Danish fund planning to decrease their level of hedge said: "The losses on interest rates swaps connected with an increasing interest rate level have to be settled in cash".
A total of 44.5% of respondents agreed that all pension funds should consider longevity swaps, while 11% felt longevity swaps would be effective in reducing their fund's exposure to rising longevity. "Longevity is a significant risk pension funds should consider. They have to ensure that interest rate, inflation and credit risk is managed properly," said a German fund. However, 26% felt the use of standardised mortality data makes swaps ineffective and 7.5% thought there were better strategies available for hedging longevity risk than swaps.
The majority of respondents felt reinsurers were the best counterparties in longevity hedging. A UK fund said: "Ultimately this is where the liabilities will end up so why pay the ‘middle men", while a Danish fund said only the future would show which kind of counterparty had the best expertise. Insurers (15%), and investment banks and specialist ILS fund managers (both 4%) were far less popular.
Some 46% of respondents said specialist advisers were best placed to give advice on longevity, but 23% felt good governance meant funds must undertake this work themselves. As well as this, 19% felt traditional consultants could offer the best advice, and 12% thought others (such as actuaries according to one Croatian fund) or a combination of advisers was the best option. "You really need to get advice from all categories: investment banks, traditional consultants and specialist advisers to understand what is going on in a relatively new area", said a UK fund.
Just under half (43.5%) of respondents felt that growth assets are their pension fund's best ‘hedge' against rising inflation and longevity. All respondents had equities as part of their fund's growth and inflation asset portfolio, 85.5% had real estate, 64.5% inflation linkers, 50% commodities and 35.5% infrastructure.