News & analysis
Interest hedging up as demand for inflation- protection strategies falls
Interest rate hedging in the final three months of 2018 jumped 9% to £31.7bn, according to a liability-driven investing (LDI) survey.
This was in contrast to a 9% decline in inflation hedging to £22.1bn compared to the previous three months, a poll of derivative trading desks in investment banks by asset manager BMO has discovered. Buyouts were a catalyst with insurers buying swaps to match liabilities during the quarter, while pension scheme hedging was biased towards leveraged-gilt hedging strategies.
Mortality decline wipes £20bn off defined benefit scheme deficits
The life expectancy of those who celebrated their 65th birthday last year has fallen by almost six months, according to a body that provides information to Actuaries. Continuous Mortality Investigation (CMI) believes that men and women who reached the milestone in 2018 will live for around another 20 and 22 years, respectively, which is lower than the projections published in 2017. This will ease pressure on final salary scheme deficits, which could fall when the new figures have been fac- tored into their next valuation.
The CMI model is used by defined benefit (DB) pension schemes and insurers as a reference when assessing how long they may have to pay benefits to their mem- bers for.
BMO LDI portfolio manager Rosa Fenwick said: “Demand remained strong in bonds last quarter with the global risk-off sentiment prompting a material shift into gilts and out of other assets from overseas investors. In addition, inflation performed strongly despite growth concerns and oil weakness. “As a headwind to general bond demand, the cost of repo increased dramati- cally during the quarter.
“This was partly due to the calendar effect of year-end window dressing, but redeployment of balance sheet into other jurisdictions or business areas and Brexit concerns has meant that this change was sharper than usual and will remain, at least to some degree, post-year end,” Fenwick added,. Those surveyed had a strong conviction that interest rates would rise over the first quarter but the predictions for inflation and real rates were more nuanced.
Indeed, the revisions will wipe a combined £20bn off the liabilities of FTSE 350 pension schemes, Willis Tow- ers Watson estimates. Stephen Caine, a director and longevity specialist at the consultant, said that a six month reduction in life expectancy at 65 can knock around 2.5% of the liabilities off a typical pension scheme. “So the new model offers some respite for companies battling pension scheme deficits,” he added. According to CMI, mortality rates in 2018 are provision- ally thought to have improved by 0.7% for males and to have deteriorated by 0.3% for females, compared to 2017. Slower mortality improvements observed in the general population since around 2011 represents a new trend rather than a ‘blip’. CMI also warned that mortality improvements over the next decade will be slower than the high improvement rates recorded in the first decade of this century.
Investors turn to money markets to escape political uncertainty
Outflows from European funds fell by more than a third towards the end of 2018, according to the European Fund and Asset Management Association (EFAMA). In December, UCITS and AIFs registered net outflows of €11bn (£9.4bn), down from €38bn (£32.5bn) in the previous month. Investors appeared to be in de-risking mode as outflows from equity funds hit €9bn (£7.7bn), reversing the €3bn (£2.5bn) of inflows recorded a month earlier. Money market funds appeared to be a popular
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choice for investors. They saw net inflows of €4bn (£3.4bn), compared to net outflows of €13bn (£11.1bn) in November. The US global trade war, political uncer- tainties in Europe, monetary policy tighten- ing and concerns about economic growth caused stock market volatility and investor nervousness. EFAMA senior director for economics and research Bernard Delbecque said: “Inves- tors have grown more cautious in 2018, and this caution has been reinforced by the sen-
timent that stock markets might have reached exceedingly high levels and that monetary policy had reached a pivotal point.” However, UCITS and AIF sales were posi- tive in 2018 at €221bn (£189.2bn). “This confirms that investment funds remain attractive investment products even during turbulent times because they possess proven qualities in terms of transparency, risk diversification, investor protection and net returns,” Delbecque added.
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