The interest rate liability hedging by UK pension funds in the third quarter of this year rose by 27 per cent, BMO Global Asset Management has reported.

According to the BMO Global Asset Management LDI Survey, interest rate liability hedging activity was around £31bn at Q3 2017, up from £24.5bn in Q2.

“The syndication of the 20165 conventional bond in September 2017 galvanized demand for interest rate hedging,” BMO said. As a result of this, the third quarter was the second busiest quarter since the survey began.

BMO added that the majority of the activity focused on new outright liability hedging activity, so switching activity, where pension funds move between equivalent hedging assets in order to lock in a gain, was less popular than in previous quarters.

Furthermore, inflation hedging activity fell by five per cent over the quarter to around £20.3bn. This was due to a lack of index-linked supply during the quarter, which corresponded to a drop in inflation hedging from pension fund investors.

A significant proportion of hedging activity was also expressed via the buying of bonds, reflecting a move from swap-based hedging into bond hedging. The approaching London InterBank Offer Rate reform was also a “contributing factor” in the Q3 figures, BMO noted.

BMO Global Asset Management LDI portfolio manager Rosa Fenwick commented: “Looking at Q3 2017, repo markets were buoyant and awash with liquidity as new entrants arrived and capital was re-deployed to the UK,” “Although long term interest rates dipped during the quarter, the focus on November’s base rate hike from the Monetary Policy Committee drove a recovery in long term rates, which ended the quarter roughly unchanged. Hedging activity was dominated by de-risking trades, predominantly in the form of time based trigger programmes rather than as a reaction to market levels.”

Fenwick added: “The ability of schemes’ to access cheap funding meant that a large proportion of hedges were fulfilled in bonds. The anticipated market-wide shift from LIBOR to SONIA (Sterling Overnight Index Average) swaps may have led some market participants to shy away from adding more LIBOR based swap hedging at this time, given the uncertainty as to the precise transition mechanism to be implemented in the future.”

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