UK pensions funds decreased their inflation hedging by almost a third in Q2 2010, compared to Q1 2010, but have maintained similar levels of interest rate hedging, says F&C.

The group’s latest LDI Survey shows that inflation hedging was unusually high at the start of the year, but by early April, RPI swap levels looked unattractively high with 30-year RPI swap rates hitting 3.9 per cent – the highest level since summer 2008.

F&C attributed the fall in inflation hedging to a combination of unattractive market levels, an acute and prolonged period of pre-election wariness, and renewed concerns about the potential for a ‘double-dip’ recession, as well as deflationary fears. This, F&C said, meant that a considerable volume of hedging activity was put on hold.

Low levels of new liability hedging was experienced due to low swap rates, particularly sharp falls in May as gilt yields further retreated. Some pension schemes have tactically reduced their interest rate hedging with the expectation of buying back at cheaper levels in the future.

Concern is also growing about Eurozone debt, and possible implications that this will have on global growth and inflation.

The quarterly report is based on responses from the derivatives trading desks most closely involved in pension liability hedging at major investment banks.

Derivatives fund manager at F&C, Alex Soulsby, said: “Since the recent announcement of the use of CPI for private sector pension schemes there has been concern about the demand for inflation hedging using RPI products. However, the index linked gilt syndication on 27 July was attractively priced and demand was much larger than expected. This seems to suggest that these concerns are exaggerated.”

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