Sponsored article
2. Target an appropriate liability hedging level
Trustees face the challenge of balancing required exposure to growth assets with allocating to govern- ment bonds to reduce liability risk. This is where incorporating leverage, through swaps or synthetic bonds, can be a vital risk reduction tool. Returning to the example scheme, the diversified portfolio only hedges 35% of the scheme’s liability risk owing to the low government bond allocation. However, the liability hedge ratio could be increased to 80% by using leverage. This would reduce the FLaR by a further 10%, whilst still maintaining a similar expected return.
3. Collateral and cash-flow management
The drawback of leverage is it requires the scheme to maintain sufficient collateral. This requirement for cash has been exacerbated by more and more pension schemes becoming cash-flow negative. It goes without saying that ensuring efficient collateral management is a key part of the solution. Additionally, employing a cash-flow aware approach can help schemes mitigate this risk. Cash-flow negative schemes can be adversely affected during periods of heightened volatility where they need to liquidate assets to pay pensions. This can be at prices that may have strayed significantly from “fair value” and so losses are crystallised. Moving towards a cash-flow matched portfolio not only reduces this early sale risk but also reduces re-investment risk.
4. Currency exposure can mitigate risk
A bonus of diversifying assets globally is this leads to foreign currency exposure. Choosing a currency hedge ratio is not an exact science but we believe maintaining some exposure to foreign currency is an important risk mitigation tool. This is because of the exposure to safe-haven currencies such as the US dollar, Japanese yen and Swiss franc, which have historically been known for rallying when there are market downturns.
Past performance is no guarantee of future results. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. The Information in this document (a) is for information purposes only and we are not soliciting any action based on it, and (b) is not a recommendation to buy or sell securities or pursue a particular investment strategy; and (c) is not investment, legal, regulatory or tax advice. Legal & General Investment Management Limited. Registered in England and Wales No. 02091894. Registered Office: One Coleman Street, London, EC2R 5AA. Authorised and regulated by the Financial Conduct Authority, No. 119272.
April 2019 portfolio institutional roundtable: Managing volatility 25
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32
