Interest rate and inflation hedging activity increased in the second quarter of 2020 amidst uncertainty around the economic outlook, according to the latest BMO Global Asset Management LDI survey.
Total interest rate hedging activity by pension schemes rose by 3%, to approximately £43.5 billion, and inflation hedging activity increased by 12%, to £39.6 billion. Activity comprised both hedge increases and switching between hedging assets.
The heightened use of credit as part of a hedging or cashflow driven strategy was a particular theme during the quarter. Where pension schemes were able to access credit rapidly, either via physical or synthetic instruments, they were able to seize the opportunity of a fleeting but dramatic cheapening in credit spreads. There was also a sharp increase in schemes’ use of swap based hedging strategies.
Rosa Fenwick, LDI Portfolio Manager at BMO Global Asset Management said: “During the second quarter there was a steady flow of hedging activity, as the market turmoil of March concentrated minds on the appropriate hedging level for individual schemes. Repo spreads blew out considerably in March, yet have now returned to their prior levels, and the increase seen in the use of swaps may have been a response to that squeeze and an effort to diversify funding requirements to defend against the risk of a repetition.
“Further delays to the outcome of RPI reform also pushed many beyond their limit of patience. That inflation hedging increased, despite further delays to the reform consultation, reveals the importance of prudent risk management, particularly at a time of higher volatility and an uncertain future post-Brexit.”