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UK DB liability hedging surges 23% year-on-year

UK defined benefit pension schemes are choosing to hedge more liabilities in spite of rock-bottom bond yields, with the volume of liabilities being hedged increasing by 23% in 2016 to £908bn (€1,024bn), according to a new study by KPMG.

Its June 2017 UK Liability Driven Investment (LDI) Market Survey, which uses 2016 data, also showed that the number of pension schemes using LDI as a risk management tool climbed to 1,808 from 1,423 a year before.

Barry Jones, head of LDI at KPMG, said: “This year‘s KPMG LDI survey confirms that LDI remains the most important de-risking tool for UK defined benefit pension schemes, with growth continuing to be relentless despite record low yields.”

Established providers still dominated the market for LDI products, he said.

The survey showed that LGIM was still the largest provider, with the firm hedging 42% of Total UK DB liabilities.

LGIM, Insight and BlackRock continued to be the largest managers within segregated LDI, the study revealed.

Within pooled LDI, these three managers along with BMO and Schroders were the biggest providers, the data showed.

“Unless the insurance industry creates a lot more capacity for pension schemes, there will be an increased need for well-funded schemes to create their own risk controlled annuity payment streams over the long-term,” Jones said.

KMPG expected LDI to become increasingly important in the current environment and predicted further LDI growth in the years to come, he said.

“Furthermore, LDI managers appear to be on the front foot in developing cash-flow delivery solutions to operate alongside their existing LDI ranges and build on their credentials in cash-flow modelling and hedge design,” he said.

According to the study, providers are continuing to develop new types of product in the LDI market segment, with new LDI funds being launched last year which combine LDI with growth assets such as equities or diversified growth funds.

In the survey, 82% of LDI managers said regulation was the most important issue facing the LDI industry in 2017.

Some 44% of managers said the central clearing of derivatives was the most important issue facing the sector, and 38% cited other regulatory or legislative changes.

Commenting on the survey results, Shaj Alam, head of solutions research, UK LDI at AXA IM, said that even though some £900bn of liabilities were now hedged, there was around £1trn that remains to be hedged, which meant there was still plenty of room for growth. 

“The survey confirms that a quiet revolution is afoot – pensions schemes are maturing and increasingly need to meet pension payments from their assets,” he said.

This had translated to demand for LDI managers to respond with solutions that generate cash, leading to innovation in the industry, Alam said.

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