Industriens trims strategy with hedges

Industriens Pensions’ invested portfolio, which is expected to grow significantly over the next few years as a result of increasing contribution payments, consists of a broad range of asset types, of which shares – according to the investment framework drawn up by the board – may constitute between 25 and 45%. Foreign shares comprise around two thirds of the share portfolio and are administered by means of external global and regional mandates.
Share derivatives are not employed in the daily portfolio management, but options and futures in share indices may be employed for the hedging of share risks with regard to the protection of the reserves if, as a result of the market development, there is deemed to be a need for this. As hedging with derivatives is associated with costs and/or involves total or partial cutting off from exchange rate profits in a rising market, it has been deemed appropriate to formulate an operational strategy for when and how share risks are to be hedged. The strategy employed formed the basis of the fund’s entry to the IPE Awards.
Industriens’ strategy for hedging share risk was drawn up with a view to ensure that the company is not given a ‘red light’ under Danish investment rules and that it could be based upon objective criteria, whilst being rendered operational with growing investment assets.
The strategy may be said to be built up around a risk budget, in that it takes its point of departure in two risk scenarios set up by the inspection authority Financial Supervisory Authority (Finanstilsynet) and the statistical risk objective value at risk (VAR). The authority operates two risk scenarios – ‘yellow’ and ‘red’ lights. A company will be in the red light if it cannot withstand a development such as a share price fall of 12%.
VAR is calculated for the total investment assets and is based upon historical market development over a three-month period. assets and position in relation to the Financial Supervisory Authority’s light system, for example with a view to assessing the need for hedging share risks.
If Industriens finds itself in the area in which it may undertake hedging, but does not do so, then the risk on the investment assets must not be increased as a result of new investments in shares. This applies to both tactical adjustments and the placing of new contributions from members. A tactical adjustment to shares will thus always be accompanied by hedging. A placing of new contributions in shares will only be able to be accompanied by hedging if a relatively large proportion of the new contributions is placed in shares.
The great strength of Industriens’ hedging strategy for the share risk, lies in the fact that a hedging that is undertaken affects both the buffer to the red light as well as the company’s risk measured by VAR. In this way, after a hedging has had to be taken, one will also compare relevant sizes. The relevant buffer, including the effect of the hedging, is thus compared with the relevant risk of coming into the supervisory authority’s red light zone, namely VAR including the effect of the wholly or partially hedged foreign share portfolio.
Moreover it is a strength that the strategy is based upon objective criteria and is easy to communicate, and does not require a position in relation to anticipated market development.
In general share hedges that are undertaken are closed again, wholly or partially, if this does not bring Industriens into the zone where hedging shall take place.
There are no restrictions imposed upon the choice of hedging method, although futures may only be employed if Industriens is in the hedging zone. The background to this is that, upon employment of futures, one achieves a cheap and effective hedging but, at the same time, debars oneself from the opportunity to participate in price increases. Therefore Industriens believes this instrument should only be employed in situations where it is necessary to close off the risk entirely.
The choice of options strategy with regard to strike, possible collar and the extent, as well as running time, will depend upon the actual market conditions and expectations.
Hedging is effected by means of a portfolio of instruments on stock exchange quoted share indices that is compiled so that it reflects the development in Industriens’ benchmark, MSCI World, in the best possible way.

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