DB schemes to reach peak LDI levels by 2021 – Hymans Robertson

The use of liability driven investments by UK defined benefit pension schemes is likely to peak and come to an end by 2021, Hymans Robertson has claimed.

According to a new report by Hymans Robertson and global investment bank Nomura, net flows into LDI will continue at current levels for the next three years at most.

The report noted that pension funds are currently hedging at a rate that has brought with it an estimated £100bn of notional interest rate exposure yearly for the past couple of years. If this rate continues, schemes are likely to be fully hedged up to their asset level by 2021, Hymans Robertson and Nomura reported.

Notional interest rate and inflation hedging also exceeded 75 per cent of private sector DB assets, equivalent to around 55 per cent of gilt liabilities by March 2017, the survey indicated. Hymans Robertson explained that around £1.2bn of notional interest rate risk is hedged at present and schemes “will not materially hedge above asset levels of about £1.5tn”.

With this, the report pointed out that if pension funds’ LDI investments do slow significantly, then the premium that UK gilts trade at in comparison to global peers may reverse.

Summarising its key finding on LDI levels, the report stated: “If schemes did continue to buy at the pace they have over the past couple of years, they would be broadly fully hedged against yield movements up to the level of their assets in around 2021.” Adding that it is increasingly likely that the pace of purchase by DB schemes would “drop dramatically” in three years’ time and so the pace of buying is expected to “slow substantially” in the coming years, if this hasn’t already taken place.

Hymans Robertson partner Jon Hatchett said: “Since its emergence around 15-20 years ago, LDI has grown incredibly rapidly, but we believe that we are nearing the age of peak LDI. We are close to a point in the UK where DB schemes will only increase rate hedging at the margin in an opportunistic manner. Our research suggests that notional interest rate and inflation hedging exceeded 75 per cent of private sector DB assets by March 2017.

“At that [current] pace, and given the high level of hedging already in place, we expect to see schemes fully hedged up to the level of their asset bases in the next three years.”

Nomura head of solutions sales, EMEA Richard Boardman added that the “abrupt slowing of pension scheme money flowing into hedging assets”, could have a significant impact on bond yields and ultimately affect DB scheme funding levels. As a result schemes should consider this impact when deciding on their investment strategy and hedging decisions, he advised.

“UK DB pension schemes promise pensions to over 10 million people, underwritten by thousands of UK companies. Collectively they invest c£1.5tn of assets, hundreds of billions of which supports the UK Government bond market. Our work suggests that their approach to investment is going to undergo a fundamental shift in the next few years. The ramifications of this shift are important to understand, given the consequences for all involved,” the report concluded.

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