Catherine Darlington, portfolio manager and Chris Adolph, head of transition management, EMEA
The recent financial crisis has led not only to reduced funding levels within the majority of pension funds globally, but also to increased volatility around those levels due to increasing volatility in both asset and liability values. Consequently, funds are now, more than ever, looking to adopt investment strategies that are more closely aligned with meeting their liability obligations.
This liability-based approach to investing has evolved from simple hedging of inflation and interest rate risk into a more holistic investment process. Funds are now looking to liability-focused investment strategies that maximise the use of all of a scheme’s assets to meet their liabilities, whilst minimising unrewarded risk.
Hedging and the impact of low interest rates
However with interest rates at historic lows, many investment managers perceive the cost of interest rate and inflation hedging to be high. For example in the UK, with sterling interest rate swaps trading at a significant premium to government bonds since late 2008, funds are exploring alternative funded options and more dynamic approaches. Funds face conflicting desires to reduce the funding level volatility by hedging liability risk and to allow the liabilities to decrease in value when interest rates inevitably increase.
Russell firmly believes liability hedging is not to be ignored in a low interest rate environment, it just needs to be looked at from a more creative and opportunistic mindset. Opportunities to benefit from hedging do exist that take advantage of market pricing opportunities.
Benefit of an experienced transition manager
Implementing a liability hedging programme is a major portfolio reconstruction assignment. To manage the risk and costs of the strategy, an experienced transition manager is needed. The transition manager must have the expertise to monitor trading trigger points and work closely with the asset managers and advisors involved. A transition manager can bring a more dynamic approach to de-risking as they can offer the flexibility to implement a variety of different strategies, ranging from a coordination role to full implementation.
As clients have continued to develop more bespoke and sophisticated approaches to asset management, transition managers have been honing their skills to deal with the challenges of liability driven investing. Transition managers can be a vital resource to help clients navigate the additional legal and operational considerations for transitions in this investment space.
