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UK pension funds focus on inflation, rate protection as LDI market grows

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The UK liability-driven investment (LDI) market continued to grow in 2013 as the value of allocated assets broke £500bn (€628bn), with a 21% increase in the number of mandates, research shows.

Annual research from consultancy KPMG showed the level of assets from pension funds reached £517bn by the end of last year, an addition of £74bn.

During 2013, in an alteration from the year previous, growth in liability hedging was shared equally between inflation risk and interest rate risk, compared with 2012, where inflation caused more concern to schemes.

This trend has continued into 2014, according to additional research from asset manager F&C.

Quarterly figures, gathered from derivatives trading desks, showed interest rate liability hedging grew an additional 9%, which the firm put down to an increase in funding levels boosting risk-reduction.

The manager said pension funds’ previous interest in inflation hedging had led them to add interest rate mechanisms to create real rate hedges.

Inflation hedging decreased for the second quarter running. However, even interest rate hedging remains below a record of £23.4bn set in the third quarter of 2013.

KPMG’s research, brought together using figures from LDI managers, showed growth in the use of swaptions within LDI strategies, albeit to a limited audience, generally larger schemes.

Allocations grew by £9.8bn over 2013, but the number of pension funds utilising swaptions was still only 25.

Other synthetic return generating approaches were not as popular, with some strategies seeing a decline in allocations.

The use of equity options within LDI strategies fell, with small growth in the use of futures and total return swaps in equities. However, the use of these strategies remained limited.

As with swaptions, the concept of LDI also remained fairly limited and under-utilised by schemes smaller than £50m.

Some 21% of the 825 mandates seen to date have been used by schemes of this size.

KPMG said there was not significant appetite for LDI strategies, despite some allocations from smaller pension schemes, .

“There appears to be plenty of opportunity for small schemes to access well structured and good value pooled vehicles,” the KPMG report said.

“It seems the demand from small schemes is much less than from larger schemes.”

With regard to implementation, schemes larger than £500m implemented segregated and bespoke mandates from managers, while those between £50m and £500m have appetite for this and pooled mandates.

KPMG’s report also predicted further growth in the LDI market through 2014, as funding levels continue to improve for UK schemes.

Barry Jones, head of LDI at KPMG, added: “With many pension schemes looking to lock in the profits following another bumper year for equities, we’d expect another wave of de-risking in 2014, and the LDI market is likely to be the primary recipient.”

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