Pension funds continue to hedge in uncertain markets

F&C's latest quarterly survey shows a continued level of inflation hedging and a slight decrease in interest rate hedging by pension schemes compared to previous quarters.

There was moderate nominal hedging despite the unattractive market swap levels as pension schemes took advantage of the inversion between gilt yields and swap rates. Exposure has been attained both physically and through the use of synthetic hedging instruments. Total return swaps have enabled pension schemes to enter into gilt and index linked gilt trades by financing the position for the medium term (typically three to six months). 

During the last quarter pension schemes have been unwinding swap based hedges and entering into total return swaps for the yield pick-up. The main focus last quarter was the cheapness of inflation that was implied by index-linked gilts and pension funds have pursued this opportunity using total return swap strategies.

Q3 results show inflation hedging continued at similar volumes to previous quarters. Market levels were attractive and hedging continued despite the uncertainty around the Government's planned switch from RPI to CPI indexation. Respondents predicted less attractive RPI levels which could lower demand.

 Alex Soulsby, Head of Derivative Fund Management at F&C commented: "Pension funds are taking an increasingly tactical approach to their LDI hedging. Often this means that they are switching between swaps, gilts and index-linked gilts to take advantage of value opportunities. The cheapness of inflation that has been implied by the index-linked gilt market this summer is an example of an opportunity that pension funds where quick to capitalise on."  

The F&C LDI Survey is conducted on a quarterly basis by F&C's Asset Liability Management (ALM) team and is based on responses from the derivatives trading desks most closely involved in pension liability hedging at major investment banks.