Pension funds could earn around 8 per cent a year undertaking a bank capital relief strategy, it has been said.
A report by Aon on bank capital relief found that the strategy could offer an income of 8 per cent per annum over five years, while it “should exhibit low performance volatility”.
The financial crash of 2008 meant that measures were taken to balance sheets and improve capital ratios, of which bank capital relief emerged as a strategy.
The report, which analyses what the strategy looks like within a portfolio, said that it will provide a “sufficient reduction in a bank’s capital requirements to support sustainable excess returns versus risk” and that it also has a “sufficient reduction in a bank’s capital risk”.
It said: “The primary risk of the strategy is a significantly greater loss than expected in the reference portfolio on which the fund sells protection.
“When accumulated losses exceed the attachment point retained by the bank, the investor will automatically start to experience capital erosion, ie, the investor’s exposure is not linear to the default losses on the overall loan portfolio.”
Despite this, the firm believes that the strategy will aid diversification within the portfolio, “significantly uncorrelated with traditional equities and fixed income”.
“The strategy remains niche and, in our view, requires a specialist skill set with considerable experience in implementing and structuring these transactions. Manager selection is therefore critical to successful investing in this area,” it added.