What Brexit Means for LDI | Chief Investment Officer

If you run a UK pension fund, closing that deficit just got a whole lot harder.

Government bond yields plummeted in the day-and-a-half of trading since the UK public voted to leave the European Union on June 23. This morning, 10-year gilt yields fell below 1% for the first time, pushing up defined benefit pension deficits.

Stock market losses exacerbated the effect on shortfalls, with consultancy firm Hymans Robertson estimating that the combined deficit of UK corporate pensions hit £900 billion ($1.2 trillion), based on aggregate liabilities of £2.2 trillion.

It’s bad news too for those pension funds implementing liability-driven investment (LDI) strategies.

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“Schemes with lower hedge ratios will have suffered, and it seems likely that yields will remain depressed given the uncertainties,” said Hemal Popat, principal at Mercer.

Interest rates and gilt yields are expected to remain at these ultra-low levels for even longer than previously thought, Popat added.

Earlier this year, some consultants were already warning that conventional LDI strategies were not as attractive based on asset pricing.

David Bennett, head of investment consulting at Redington, said LDI implementers should monitor the effect of market movements and interest rate changes on their entire portfolio.

“If there’s a further fall in interest rates resulting in increase in the value of your LDI strategy as a proportion of your portfolio, then you have to think about rebalancing,” Bennett said.

However, he emphasized that Redington would be advising clients to maintain current strategies while seeking opportunities to increase their hedging.

“We briefly debated whether there is a point at which rates would get too low and you shouldn’t hedge,” Bennett added. “Would you hedge if rates were at zero? We think that’s a long way off.”

Martijn Vos, managing director at Netherlands-based consultant Ortec Finance, said many European pensions were “already adjusting for a low rate, low growth environment” while also grapping with a “low risk budget.”

Dutch pensions in particular struggled regarding funding positions even before last week. “The immediate reaction was limited, but it’s very clear [Brexit] will make rates stay low or get even lower and make it even more difficult than it already was,” Vos said.

Disappointed with your hedge fund returns? Take a gamble on a (very) alternative asset class, researchers have suggested.

Sports betting can serve as a source of uncorrelated excess returns, according to research analysts at UK hedge fund Long Rock Capital. Lovjit Thukral and Pedro Vergel Eleuterio found that systematic investments in betting strategies can outperform both hedge fund managers and the S&P 500, while also providing diversification.

“Sports trading can provide an attractive option to investors as an alternative asset to generate excess returns which are uncorrelated to their existing portfolio,” they wrote in a paper published earlier this month.

According to Thukral and Eleuterio, sports betting fits perfectly into modern portfolio theory, as sports events “in theory have no impact on the financial markets.”

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For the study, the researchers modeled a simple strategy of betting on UK horse racing 2010 to January 2016 using historical data from online bookmaker Betfair Exchange. The strategy consisted of ‘laying’—betting against an event occurring—the four horses most favored to win in each race.

Returns topped the S&P 500 on average over the last six years, as well as the Credit Suisse Hedge Fund Index. But volatility was extreme. Annual performance peaked in 2013 at 34%, when hedge funds gained 10% and US equities returned 31%. It bottomed out at negative 7% in 2015—when hedge funds returned 0% and the S&P 500 earned 1%.

“This shows the potential of sports betting strategies as an alternative investment and a unique way of gaining uncorrelated exposure to the market,” Thukral and Eleuterio wrote.

Although the researchers only looked at one sport and one type of strategy, they said they were “confident that this is only the tip of the iceberg” in using sports for alpha.

sports betting asset class Source: “Sports Betting as a New Asset Class: Can a Sports Trader Beat Hedge Fund Managers From 2010-2016?”