Asset Allocation

Hedges Break Records as Investors Fear Inflation

<i>Investors are uncertain and fearful as markets remain choppy – hedging risk is on the up.</i>
Reported by Featured Author

(May 24, 2012)  —  Inflation hedging hit record high levels across the United Kingdom in the first quarter of this year as investors feared uncertainty and the impact rising costs would have on their ability to meet future payments.

Some £13.9 billion was hedged in the first three months, nearly double the amount hedged in the same period last year, according to asset manager F&C Investments’ latest Liability-Driven Investment (LDI) survey.

The survey asked investment bank trading desks about their activity in the quarter. F&C said respondents cited attractive market levels as a spur to investor willingness. The company said in the first quarter of the year, the average Retail Price Index (RPI) swap rate was 3.5% compared with 3.7% in the last three months of 2011; for a typical pension scheme this could translate to fixing liabilities at roughly 4% lower.

Alex Soulsby, Head of Derivative Management at F&C, said: “Unconventional and untested policies like quantitative easing are causing pension schemes to focus on protecting against the risk of future high inflation. Although current inflation remains high, prices for long term inflation hedges are attractive.”

Conversely, the level of interest rate hedging fell in the last quarter, down from a record level of transactions in the last three months of 2011.

Soulsby said: “The results of our survey demonstrate the uncertainty inherent in the economic outlook at the moment. As Europe edges closer to the precipice with further downgrades in Spain, the UK’s AAA rating remains, therefore gilts will retain their safe haven status for now. However, internal risks are increasing as data now shows the UK to have been in a technical recession since Q4 2011. This uncertainty makes the consideration of whether to hedge with bonds or swaps all the more difficult for trustees.”

This week, the Bank of England announced that inflation in the UK fell last month. Analysts at Societe Generale said this fall left the door open for more quantitative easing, which has been seen by most as a negative for pension fund investors.