One year on from the gilts crisis and XPS Investment has conducted a comprehensive analysis of hedging activity across its client base, by assessing liability hedging changes in 178 pension funds between June 2022 and June 2023. This sample, representing 81% of our client base by value, provides an indication of the wider LDI market in the absence of market wide information which is currently being collected by the PPF and the Pensions Regulator.
Pension schemes have increased their hedges: The analysis found that the average XPS investment client, weighted by asset value, has increased its liability hedge by 3% between 30 June 2022 and 30 June 2023. Over the same period, aggregate UK defined benefit scheme funding levels are estimated by XPS to have improved by 17% when measured on a low risk liability basis.
This demonstrates that, far from being put off LDI as a risk management approach, pension schemes have employed it to further protect the funding level improvements that we have been witnessing.
Hedging activity greatest in smaller schemes: Schemes of all sizes have increased their hedging on average, but schemes below £10m increased hedging on average by 16% and schemes between £10m-£50m increased hedging by 10%. This in part reflects the greater scope smaller schemes have to increase their hedges given the lower initial hedging levels.
22% of schemes have a lower level of hedging compared to a year ago. This was either as a consequence of lost exposure during the LDI crisis or as a strategic decision in light of a need to appropriately manage liquidity and other operational factors going forwards. By number, 35% of XPS’s investment clients increased their hedging and for 43% it has remained unchanged.
Lower fees earned by LDI managers: Fees paid to pooled LDI managers are estimated to have fallen by 7% over the last year as a result of rising gilt yields depleting the size of LDI funds, despite increased hedging by pension schemes and LDI funds running greater cash buffers. We have not seen LDI managers seeking to change their fee arrangements. Fiduciary Managers have also been impacted by falling asset values with their revenues typically linked to the value of assets they manage. XPS has observed an emerging trend of some Fiduciary Managers materially increasing their fee to offset the falls in asset values and revenues.
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