Pension Hedging Inefficiencies

Download Pensions Hedging Inefficiencies

In this White Paper we consider a case study of the ABC Pension Fund which recently completed a Liability Driven Investment (LDI) strategy review. By taking advantage of the latest technology available in pension risk management, not only did the Fund achieve a more accurate optimal solution, but also saved almost £2m in execution costs.

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Contents

By taking advantage of the latest technology available in pension risk management, not only did the Fund achieve a more accurate optimal solution, but also saved almost £2m in execution costs.

• Background
  Following a comprehensive risk review, the Trustees of the Fund decided that in the context of being closed (and therefore maturing), together with concerns about the strength of the Sponsor's covenant, the current level of risk was no longer appropriate.
• Swap Strategy
  The use of interest rate and inflation swaps to hedge pension risk is now relatively well understood, having been executed by a significant number of pension funds.
  • Interest rate swaps
  • Inflation swaps
• Designing an appropriate swap portfolio
  Traditional methods applied to designing interest rate and inflation swap portfolios do not always fully capture the underlying risk exposure - Typically, this work falls into a gap between the capital markets and the actuarial world.
• A more sophisticated approach
  To determine an accurate hedging program for a pension fund, it's important to have a detailed understanding of the risk exposure at the individual member level.
• Contrasting the two approaches
  The more sophisticated hedging approach results in a materially improved hedging strategy.