UK – Delegates at the National Association of Pension Funds (NAPF) conference have been told that most pension schemes will use swaps in the future – although the complexity and complication of the market was acknowledged.

“Swaps will be used in most pension schemes going forward,” said PIMCO’s Mike Amey at session on swaps at the NAPF in Edinburgh. The session moderator, Sue Timbrell of Transport for London, said swaps were a “very complex and complicated subject”.

The swaps market is worth 40 trillion-dollar in open interest terms said Henderson Global Investors’ William Nicoll. “It is big, it is strong and it’s not going to go away.”

He explained that swaps offered more flexibility than bond investments to meet liabilities: “This is best way to match that we have at the moment.”

A feature of the market is that there needs to be a contractual agreement between the pension fund and the investment bank. “Banks need to be protected from pension funds and pension funds needs to be protected from investment banks,” he said. Nicoll added the inflation risk market was “growing by the day” - mainly driven by pension funds.

Amey told the well-attended session that swaps enable a pension fund to manage asset and liability cash flows. “It enables you to create the cash flows you want.” He acknowledged the market was complex, but said: “It’s our job as portfolio managers to take the burden away from you.

He said that swaps are efficient tools for liability driven investment in that they smooth out the “lumpy” cash flows from bond investments. The swaps market, he said, can be used to passively match cash flows, while the fund still retains the underlying assets. In effect, they neutralise liability risk.

“We think that’s a pretty convincing argument why you as trustees should check out this market,” Amey said. He added that swaps can also provide useful information about market expectations, giving a much more efficient portfolio.

Not all schemes are legally allowed to invest in swaps, Nicoll said. And some trustees are wary of the contractual agreements that need to be signed.

Amey said the ‘operational risks’ of using swaps were “more perceived than real” and were minimal compared to the advantages. In terms of tax, Nicoll said the UK authorities treat swaps as investments.

Amey concluded: “The momentum is there and it’s our responsibility as fund managers to tell people about them.”

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