Total interest rate liability hedging activity in Q3 2017 was around £31 billion, up from £24.5 billion in Q2 2017. The syndication of the 2065 conventional bond in September 2017 galvanized demand for interest rate hedging, making the quarter the second busiest since the survey began*.
The majority of this activity focussed on new outright liability hedging activity meaning that switching activity, where pension funds move between equivalent hedging assets in order to lock in a gain, played less of a role than it has previously.
Inflation hedging activity decreased by 5% over the quarter, to around £20.3 billion. The lack of index-linked supply this quarter corresponded to a fall in inflation hedging from pension fund investors, who often focus their hedging appetite at supply events.
“Looking at Q3 2017, repo markets were buoyant and awash with liquidity as new entrants arrived and capital was re-deployed to the UK,” said Rosa Fenwick, LDI Portfolio Manager at BMO Global Asset Management. ““Although long term interest rates dipped during the quarter, the focus on November’s base rate hike from the Monetary Policy Committee drove a recovery in long term rates, which ended the quarter roughly unchanged. Hedging activity was dominated by de-risking trades, predominantly in the form of time based trigger programmes rather than as a reaction to market levels.”
Hedging activity was mostly expressed via the buying of bonds, reflecting a continuation of the desire to switch out of swap-based hedging into bond hedging. This is predominantly due to bonds yielding more than swaps at most maturity points and investors showing increased confidence in accessing repo funding. The impending LIBOR (London InterBank Offer Rate) reform was also a contributing factor.
Rosa Fenwick added: “The ability of schemes’ to access cheap funding meant that a large proportion of hedges were fulfilled in bonds. The anticipated market-wide shift from LIBOR to SONIA (Sterling Overnight Index Average) swaps may have led some market participants to shy away from adding more LIBOR based swap hedging at this time, given the uncertainty as to the precise transition mechanism to be implemented in the future.”
LDI fund innovation
In Q3 2017, BMO Global Asset Management announced the launch of its new range of liability-based profile funds. The innovative set of profile funds support the full lifecycle of a pension scheme’s funding journey. By replicating actual pension liability cashflows, the profile funds offer material benefits compared to traditional single-maturity bucket funds, in addition to reflecting how investment markets have evolved over recent years. BMO Global Asset Management is the first asset manager to offer a comprehensive start-to-finish range of LDI strategies in liability-based profile funds.
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