UK Pension Funds like Highly Leveraged Hedge Funds
25 May 2012 (PLANSPONSOREurope.com) - UK pension funds need to better manage investment risks due to their similarity to a highly leveraged hedge fund, according to investment adviser Cardano.
Cardano says most UK pension funds are like highly leveraged hedge funds.
Phil Page, Client Director at Cardano UK, commented: “UK pension funds generally take three very large risks based upon their large and static exposure to equities and lack of much interest rate or inflation hedging. The lack of interest rate and inflation hedging exposure means that their funding deficit grows if the price of index-linked gilts and conventional gilts rises. This is effectively equivalent to a ‘short’, or negative, position in gilts which hedge funds are more accustomed to taking. Because most UK pension funds are underfunded, the short positions in index-linked gilts and conventional gilts are huge, often being greater than the fund’s asset value. Effectively, they are running a highly leveraged hedge fund, but with only three big undiversified risks, all of which have gone against them over the last 10 years.
“As most pension funds are now maturing fast, the dangers are whether the fund actually has enough time for these risks to pay off. This is even more uncertain in the current economic climate where the risk that gilt prices remain high, and equities face headwinds, may continue for some time. Trustees should think clearly and deliberately about which risks are worth taking in today’s market environment, rather than doing what the industry has always done. This may involve increasing some risks in pursuit of good returns, but reducing others to give a more diversified risk allocation.”