Consultants: Pensions, While Hesitant, Likely to Increase Derivative Use

While schemes are still reluctant to use derivatives, pension funds are increasingly using these investment vehicles to hedge against interest-rate risk, consultants say.

(October 17, 2011) — While there is still a general concern among institutional investors about effectively using derivatives, schemes are increasingly using these investment vehicles to hedge against interest-rate risk.

“We’ve seen a growing number of especially corporate pensions using derivatives as they pursue liability-driven investment,” Strategic Investment Solutions’ Managing Director John Meier told aiCIO. “If you’re trying to lower pension surplus interest rate risk, using derivatives is definitely effective in order to maintain a reasonable level of return.”

Mercer consultant Gordon Fletcher voiced a similar perspective, noting that he has witnessed a much greater interest in derivatives among corporate funds as they look into derisking strategies amid an environment of frozen legacy liabilities.

The perceived growing use of derivatives among institutional investors is supported by a June study that showed that asset owners have retained an appetite for innovation where specific principles are met, fueled by the entrepreneurial culture in the United States. The annual, independent study by CREATE-Research, commissioned by Citi’s Global Transaction Services and Principal Global Investors, revealed that schemes have welcomed new asset allocation techniques, such as the use of derivatives, to hedge out unrewarded risks. However, leverage, structured products, portable alpha, and currency funds were perceived as lacking intrinsic value.

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Despite the greater use of derivatives, Meier added: “In the US and elsewhere, I think there’s a general concern over derivatives, but if there’s adequate education about what they do and how they work, schemes can get trustees to sign on,” adding that many funds are still hesitant about the extra risks that derivatives introduce, such as basis risk — when the derivatives used to hedge don’t directly hedge with what they’re trying to hedge — and counterparty risk.

Consultants note that with derivative usage comes big challenges in terms of governance. “Investment committees meet once a quarter — they may not have much time to allocate to running a plan, and using derivatives is quite a big commitment,” Fletcher noted.

UK Pensions Mirror America — or Vice Versa?

UK-based advisers have reiterated a similar perspective of distrust over the use of derivatives, as reported by Reuters. “When the world is concerned about deflation, that is the time for a pension fund to start thinking about inflation risk. Right now, the cost of hedging that over 10 years using inflation-linked government bonds is less than the government target (for inflation),” Shalin Bhagwan, head of structuring in the Liability Driven Investment Funds unit at Legal & General Investment Management, told Reuters, noting that schemes are running out of time to hedge portfolios against inflation.

Schemes in the US and the UK aren’t widely using derivatives to effectively hedge against inflation risk, but they could be, Meier told aiCIO. “Inflation risk is a risk that institutional investors are increasingly focused on. With the markets reflecting an expectation that inflation will remain at current levels, the cost for hedging now is pretty low. This could be a good time to hedge against inflation and especially though the effective use of derivatives.”

In terms of longevity risk, Meier said that while derivatives haven’t been widely and effectively used to hedge against this type of risk, there may be opportunity for derivatives in that area of risk management. While still in its infancy stage, Mercer’s Fletcher added that UK schemes are ahead of the US in terms of using derivatives to hedge against longevity risk. “It’s certainly on the table in the future for both the US and UK,” he said.

In May, Bloomberg reported that banks are now forming death derivatives to help pension funds better manage longevity issues. According to the news service, pensions are purchasing insurance against the risk of their members living for longer than anticipated. Yet, it has become increasingly difficult to find buyers willing to take that risk, packaged in the form of bonds and other securities. JPMorgan and Prudential have set up a trade group to establish a secondary market for longevity risk, while Goldman Sachs and Deutsche Bank have created insurance companies that promise to pay pensions if retirees live beyond a certain age, Bloomberg reported.

Meanwhile, schemes are increasingly transferring risk to insurance companies, driven by merger and acquisition activity, a growing number of closures and part-closures of defined benefit pension schemes, and concerns over longevity risk. A March report by Hymans Robertson showed that UK pension buyouts, in which an entire scheme is passed to a specialist insurer, are becoming more and more prevalent.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

CalPERS Emerges as Latest News Corp Shareholder to Withhold Support for Murdochs

The California Public Employees' Retirement System (CalPERS), the largest public pension in the US, is the latest News Corp shareholder to withhold support for Rupert Murdoch and his sons.

(October 17, 2011) — The California Public Employees’ Retirement System (CalPERS) is the latest News Corp shareholder to oppose the Murdochs.

The largest public pension in the United States — which owned 1.5 million voting shares and 5.8 million non-voting shares of News Corp. as of September 30 — announced that it would vote against the reelection of Murdoch, his sons, as well as two other board members.

“Our most important protection as a minority shareowner in News Corp. is a robust and independent Board,” CalPERS spokesman Wayne Davis confirmed with aiCIO on behalf of the fund. “For that reason, we are withholding our vote from non-independent director nominees James Murdoch, Lachlan Murdoch, Arthur Siskind and Andrew Knight. The role of the independent directors is of particular importance because of the dual-class voting structure at the company. Furthermore, because there needs to be an independent chairman to oversee News Corp. at this critical juncture, we are withholding our vote for Rupert Murdoch, who is both the CEO and Chairman of the company. These are governance basics – we believe News Corp. shareowners will benefit from the company undertaking these reforms.”

The scheme added in a press release: “CalPERS expects the Board to continue its efforts to rejuvenate the News Corporation Board with new independent directors, and we will continue to engage with the company on this point.”

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Despite the opposition from institutional investors against Murdoch over the alleged circulation scam at the European operation of his Wall Street Journal and the phone-hacking scandal in recent months, the Murdoch empire has continued to fight back. According to The Independent, analysts believe Rupert Murdoch will survive attempts by shareholders to remove him from his News Corp. board at this week’s Los Angeles annual general meeting. The Murdoch family has nearly 40% of the voting rights in the company. At the same time, it owns only 12% of the equity, ensuring control of the board, the newspaper reported.

A shareholder activist body in the UK has also urged News Corp to overhaul its board structure. The Local Authority Pension Fund Forum (LAPFF), whose 54 members have combined assets of £100 billion, issued a voting alert to its members in early October on News Corp. “Having undertaken extensive research into the phone-hacking scandal, and having engaged with News Corp directly, LAPFF has reached the view that board change is necessary. The Forum believes that lead director Rod Eddington is well placed to take this process further,” according to a news release on the firm’s website. The statement by LAPFF continued: “The Forum believes that the News Corp board must take responsibility for the hacking scandal and that this would be best achieved by a change to its existing membership and structure. LAPFF believes that James Murdoch’s continued presence on the News Corp board is causing significant reputational damage to the company and is no longer in shareholders’ interest. The Forum has therefore recommended that its members oppose James Murdoch’s election.”

In September, pension funds and other News Corp shareholders brought charges against the media firm stemming from its phone-hacking scandal. The shareholders — including the New Orleans Employees’ Retirement System and Central Laborers Pension Fund — stated that the “still unfolding hacking scandal is just a continuation of the board’s malfeasance.” Shareholders highlighted cases involving several News Corp US subsidiaries which suggested that hacking, privacy breaches, and anticompetitive practices were not restricted to the newspaper division. Additionally, the filing included wrongdoing at two more Rupert Murdoch-owned companies — News America Marketing and NDS Group.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

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