UK -Pension funds hedged approximately £11.4bn (€12.68bn) in inflation liabilities in the third quarter of this year - a move which suggests attention is now turning inflation rather than interest rate risk, according to data presented by F&C's latest liability-driven investments survey.
The study, based on responses from derivatives trading desks, suggested many good investment and pricing opportunities were missed by pension funds in the first half of this year, so fund officials instead "rushed into the market during the third quarter", which in turn led to better liquidity and lower transaction costs between July and September, suggested F&C.
Interestingly, pension funds now appear concerned with the prospect of rising inflation, said Alex Soulsby, derivatives fund manager at F&C's LDI team, as there was a significant drop in the take-up of nominal hedging derivatives during Q3 2009 and a continuing rise in inflation hedging support.
"The findings very much mirror the sentiment of trustees whose primary concern is a fear of rising inflation, while they expect UK interest rates to rise," said Soulsby.
"Those who support this view cite the burden of government borrowing, inflation, economic recovery and the end of qualitative easing. Because many pension funds set target levels at which their fund managers should act, the downward move in rates over the quarter may have postponed potential hedging," he added.
F&C's data indicated the volume of UK pension interest rate liability hedging against a 0.01% change in interest rates fell from £23.775bn in Q2 2009 to £17.465bn by the end of September. In contrast, the volume of inflation hedging derivatives against a 0.01% change in RPI inflation continued to rise, after an already significant leap in Q2, to £22.885bn.
F&C has estimated that the actual liabilities hedged against interest rate rises fell dramatically from £9.034bn in the second quarter of this year to just £6.636bn in the third quarter - a drop of approximately a third.
At the same time, the purchase of inflation hedging derivatives meant UK pension funds hedged approximately £11.442bn of liabilities in that same period.
Soulsby said the fall in the amount of interest rate hedging in those three months is because pension funds now feel they are not getting value should they hedge interest rate liabilities at current market rates.
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