Pension funds decrease interest rate hedging in Q1

Arrow_downPension funds have decreased their interest rate hedging in the first quarter of the year, due to less attractive market swap levels and stagnant funding levels.

A survey by fund manager F&C reported a 24% fall in the levels of interest rate hedges in Q1 2011 with £7.5bn (€8.6bn) equivalent of liabilities hedged in this period, compared to £9.9bn during Q4 2010. Inflation hedging was broadly unchanged with £7bn of liabilities hedged.

Alex Soulsby, head of derivative fund management at F&C said: “There were no great surprises in this quarter’s survey. The decrease in nominal interest rate hedging appears to be due to a combination of the less attractive market swap levels and stagnant funding levels, causing pension funds to delay their hedging decisions.

“Inflation hedging in Q1 continued at similar volumes to recent months. Market levels also remained relatively stable over the quarter. Pension schemes' inflation concerns appear to be balanced by a reasonable level of inflation hedge supply.”

The firm said that Middle East tensions and peripheral worries in Europe kept swap rates lower while March saw the markets dominated by the earthquake in Japan and the threat of nuclear meltdown. but, despite these events, strong global growth and inflation worries in the UK meant that swap rates rose over the quarter.

The F&C survey showed that total return swaps (TRS) enabled pension schemes to enter into synthetic gilt and index-linked gilt trades by financing the position for the medium term (typically six months to three years). Pension schemes continued to switch swap based hedges into gilts via TRS for the yield pick-up.