Rates were rising and trigger points were being hit in some lever- aged LDI portfolios with cash calls made to fund these. Over the past 10 years as rates have been coming down, leveraged LDI has not only generated strong returns, but thrown off a lot of cash that has paid pensions and rebalanced portfolios. The challenge is that if it starts going the other way and there are cash calls, you have to fund that from somewhere, assuming that you want to keep your hedging. Does that then eat into the growth assets you rely on to fund your deficits?


It is crucial when setting strategies in this environment to factor in the increasing risk of rising rates and have liquidity and collateral ladders in place that will allow you to meet these cash calls without jeopardising the long-term funding of the scheme. From that per- spective, considerations of inflation are key given where we are and the fiscal response that has come our way. Thevissen: Inflation is a risk that we hedge similar to how we hedge rate risk. When it comes to liquidity/collateral management, we did not get into a difficult situation in the past few months, but it is a space that we watch. MacRae: We consider inflation and rates from the view of do we want that risk? We are heavily hedged against those risks and that has been positive while rates have been dropping. We need to look at where rates could go and the risk of higher rates. On the inflation side, the cost of hedging in the UK is high, espe- cially post 2030. We use real assets to access inflation protection in our CDI portfolio, which we overlay with direct inflation hedging. We consider the cost of hedging that risk against the reduction in volatility we could achieve, so there is a regular re-evaluation of the costs of hedging versus its benefits. In summary, if you cannot absorb the risk, you need to hedge it. If you can take some risk, and it is expected to generate returns, then you can move away from a naturally hedged position to some extent.


Pickering: There has been an unholy alliance between the sophisti- cates and the not-so-sophisticates who say there is a limit to what price you want to pay for protection against inflation. Today, the argument that the approach should be scheme specific holds good, and if the employer and trustee want to batten down all risks, they may be willing to pay a higher price for battening down the infla- tion risk.


In DC land, members might be sensible in battening down infla- tion risk if their pension is the only income they have in retire- ment. If they have other sources, they maybe more relaxed about battening down every risk. As far as volatility is concerned, it will increase as large amounts of money exploit opportunities or react to uncertainty.


As a long-term investor, volatility can be your friend, but if you have a short-term horizon, as many defined benefit schemes have, then it could be your enemy.


May 2021 portfolio institutional roundtable: Fixed income 11


Quantitative easing and modern monetary theory have promoted us to rip-up everything we learnt from


textbooks in our youth. Alan Pickering, BESTrustees


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