LDI Asset Inflows Stagnate Amid Record Low Yields
Assets invested in liability driven investments (LDI) have increased substantially during 2011, up nearly 30 percent. However, growth has been driven by strong returns in the asset class, not new mandates or the extension of existing mandates.
Hedging levels only rose by amounts commensurate to falls in gilt yields. Market share across fund managers remains concentrated across an ‘oligopoly’ of the three largest providers accounting for 85 percent of assets under management. Investment Managers’ optimism on yields rising is more muted than 12 months ago.
According to the latest research issued by KPMG Investment Advisory, UK Liability Driven Investment (“LDI”) assets under management have increased 28 percent from £243bn to £312bn in the 12 months to December 2011. However, despite this growth, the aggregate new asset inflow into LDI investments from UK pension funds was close to nil over 2011.
Simeon Willis, Principal Consultant at KPMG in the UK, commented: “Whilst assets under management increased by almost 30 percent during 2011, this was primarily driven by falling gilt yields, rather than new money. Long maturity gilt investments delivered returns of 26 percent over 2011.”
According to KPMG, the lack of new money going into LDI is a result of the all time low yields in the gilt market. Simeon Willis explains: “Although the UK pension funds’ desire to reduce risk through hedging liabilities appears to remain a high priority, the significant fall in gilt yields amidst the European Sovereign Debt Crisis and the UK’s perceived safe haven status, has meant that pension funds were unwilling to hedge at such unattractive levels.”
However, in KPMG’s view, many pension funds will need to incorporate some level of LDI into their investment strategy at some point in the future and failing to do so now could be a risky strategy, the firm warns.
“Many pension funds are still taking a ‘wait and see’ type of approach but this ‘all or nothing bet’ is a risk given the potential for yields to become even less attractive from here,” says Simeon Willis.
The 2012 KPMG LDI Survey has highlighted that over a quarter of the c.600 mandates in the survey have market level triggers in place, hoping to benefit from improvements in yields before entering the market.
“The continued decline in yields over 2011 surprised a lot of investors who thought that they simply could not get much lower,” says Simeon Willis. “Consequently, most trigger based strategies failed to increase the overall level of hedging, thereby failing to protect from the increase in liabilities that correspond to falling yields.”
KPMG draws similarities between this and prevalent pension risk management approaches that are focused on reducing allocations to growth assets in response to improvements in market levels.
“Whilst these approaches are intuitively appealing – seen to be ‘banking winnings’ – they often neglect to satisfactorily address immediate risk exposures,” Simeon Willis comments.
The survey also highlighted that within segregated and bespoke strategies, two managers accounted for more than 70 percent of the total assets under management. Indeed, KPMG’s research showed that across the industry the three largest managers accounted for 85 percent of the assets under management.
Additionally, the survey sought views from investment managers on the direction of the gilt market. Compared with 2011, optimism on yields rising in the next three years appears to be more muted with half of the managers surveyed expecting real yields to flat or fall further.
Simeon Willis concluded: “The volatility in 2011 demonstrated the tangible benefits of hedging interest rate and inflation risk for UK pension schemes. Given the uncertainty around the level and future direction of yields, we are seeing a continuing trend for UK pension schemes to revisit their trigger strategies as they appear unlikely to be hit in the medium term.”
“We are seeing clients considering more inventive strategies to increase hedging so as to capture improvements from rising yields whilst also increasing the downside protection from day one.”