Low yields forcing UK pension funds to revise LDI triggers, experts say
UK - UK pension funds that put liability-driven investment (LDI) and de-risking plans in place, in some cases years ago, have been revising their 'trigger' points downwards.
The move is a sign they are becoming concerned that bond yields could remain low for some time and that they have not been de-risking fast enough to meet their flight plans.
Gavin Orpin, head of LCP trustee investment consulting at Lane, Clark & Peacock, told IPE: "What we have seen is that some clients who had triggers in place for de-risking have come to the conclusion that the level at which they set those triggers was just over-optimistic, and they are recognising that they need to get some hedging in place sooner."
Pension funds implementing an LDI strategy in a low-rate environment or from an under-funded position often set triggers for moving assets from the return-seeking portfolio to the liability-matching portfolio, related to the level of real and nominal yields.
However, schemes that set these triggers three or four years ago appear to have been over-optimistic. As a result, they have watched bond yields sink further and further from their trigger levels, leaving them far behind their flight plan for de-risking and over-exposed to risk relative to their liabilities.
Stuart Jarvis of BlackRock's Multi-Asset Client Solutions (BMACS) group said: "We definitely have seen clients moving their trigger points - not just over recent weeks, but gradually over the course of months or even years.
"They are on a flight path, which means it's not only a question of yield levels, but also funding levels and the time dimension - you want to be getting on with things."
Orpin at LCP said one client had reduced its nominal rates trigger by a full percentage point and that others, while leaving existing triggers in place, had been gradually moving into matching assets "almost regardless" of pricing.
"We are going to see more of that because some of those triggers are just so far away now that, barring any major change in the markets, de-risking could end up being years or even decades away," he added.
Phil Page, a client manager at Cardano, confirmed that he too had seen some evidence of real-yield triggers being revised. But he said it was more usual to see triggers being left in place while new cash flows were directed straight into matching assets - again "almost regardless of price".
He pointed to lessons that could be learned from the experience of the past few years.
"If you'd set your trigger levels three or four years ago, there have been occasions when yields would have enabled you to get to a pretty fully hedged position," he argued, pointing to the fact that the yield on the 2027 UK index-linked gilt - which is a good match for the typical duration of a UK fund's liabilities - hit 1.23% in July 2010 before falling back to just 0.2% today.
"Pension funds that set their real yield triggers at 1% or 1.2% would, if they'd been nimble enough, have been able to get some of that ILG exposure at a much higher real yield [than they can today]," he said.
"But the reality was that many had set their trigger levels unrealistically high, and when they saw real yields heading above 1%, they assumed this trend would continue.
"They therefore failed to go ahead with the process of risk-reduction that they had, in principle, agreed to. The last few years clearly set out the need to set your principles and then back them up with action."