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about the health of the global economy, which is why many defined benefit (DB) schemes have been reducing risk in their portfolios well ahead of October’s leave date. But for Brunel, reducing exposure to UK equities is not on the agenda. Cox points out that many of the biggest firms listed in London are so globalised that they might be more affected by currency movements in other markets, rather than the UK market per se. It is a different story for Mark Hedges, chief investment officer of the £3.2bn Nation- wide Pension Fund. He is reducing the scheme’s
equity exposure. Despite the
scheme having a relatively higher propor- tion of active members, he is focusing on matching liabilities. “We continue to diversify our exposure which is already very global, certainly in our return seeking assets,” Hedges says. “Our matching assets are obvi- ously linked to UK liabilities, so primarily they are linked to gilts, index-linked bonds and some UK index-linked property, which also acts as a partial hedge to the liabilities, both of which have gained foothold irrespective of Brexit because they are matched to UK interest rates. “The sharp fall in rates that we have seen since the end of last year had an impact on our liabilities, but that impact has been lessened because we have increased the hedging on inflation and par- ticularly on interest rate risk. It could have been a lot worse because it was the uncer- tainty around Brexit that stimulated the fall in rates.
“It is also compounded by the global slow- down, but the bigger driver in the UK is probably Brexit,” Hedges adds. “Certainly, our deficit would have been in a much worse position had we not significantly increased the hedging over the past two years.”
This is a trend that has caught on. More than 75% of private sector DB assets are now hedged against interest rate and infla- tion risks, according to a 2018 survey by Hymans Robertson. Over the past two
years, private sector DB schemes have added some £100bn of notional interest rate exposure, the consultancy says.
CURRENCY RISKS
One of the clearest indicators that institu- tional investors could face potential chal- lenges from Brexit has been the sharp fall in the sterling with the pound sinking to a 28 month low this summer. Yet a weaker pound could also be an oppor- tunity. “The challenge that we have seen recently is the fall in sterling, which has had an effect on our foreign assets to the extent that they are not hedged for currency risk,” Hedges says. He adds that the team are considering lock- ing in some of the gains. “We run 20% of
strategy with currency forwards to try and lock in some of the gains, but if we do that and sterling falls further then we are also losing out on the value of further falls.” But making bets on how Brexit could affect the value of the pound might be a strategy that is harder to sell to risk-averse trustees, Hedges admits. “Whenever you take these tactical risks, you are forming a view that sterling is under-priced, it probably is under-priced but it’s a question of how much further it could go and for how long, we don’t know. That is the problem with tactical decisions.
“It is something we are thinking about, but I won’t know until we had a formal decision from our investment committee,” he adds. Nevertheless, he believes that this strategy
We have not changed our well thought out
investment strategy, although we remain agile enough to respond as necessary. David Cox, Brunel Pension Partnership
our portfolio in private markets, so illiquid assets like private equity, infrastructure, private credit, real estate, in Europe and Asia,” Hedges adds. “That is a global port- folio but a large proportion of it is denominated in US dollars, which we have not hedged because it is difficult. For exam- ple, with a private equity fund, you do not know when you are going to drawdown the money, you do not know how much money you are going to get back and you do not know when you are going to get it back. “One of the things we are contemplating, because we have seen the sharp fall in ster- ling, is if we can lock in some of the value from the currency gain of that translation risk. “We have about $600m to $700m (£499m - £582m) of US dollars and a 10% fall in sterling effectively increases that by about $70m (£58m), so it starts to become appre- ciable to hedge that for a period of time,” he says. “We are contemplating overlaying our
32 | portfolio institutional | September 2019 | issue 86
might be on the agenda for quite a few schemes. “Adding an overlay strategy to the macro level is certainly a strategy that pen- sion funds are thinking about right now,” Hedges says.
“Unless there is a significant sea change in the UK government’s willingness to negoti- ate, I don’t see there being a big turnaround in sterling. It seems highly likely that there will be a painful Brexit rather than a with- drawal agreement at the moment,” he predicts. Yet, since Hedges spoke to portfolio institu- tional the chances of the UK leaving the EU with an agreement increased after parlia- ment voted to block a no deal Brexit.
SCHEME FUNDING – THE £140BN QUESTION
Brexit could, and to some degree already has, affected pension scheme funding lev- els. The impact could be felt on the liabili- ties side but also on the employer covenant.
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