Pension scheme hedging activity increased in Q2 2013 following potential concerns of a rise in inflation and large rise in rates in the second half of the quarter, F&C Investments has found.

The latest quarterly F&C Liability Driven Investing (LDI) survey revealed that inflation liabilities hedged in Q2 2013 increased by 20% over the quarter, from £12.2bn to £14.6bn, as expectations that the central bank would introduce new stimulative measures raised concerns about stoking inflation.

F&C also noted that over the quarter, pension schemes became more sophisticated in their use of hedging strategies as the level of switching increased between different hedging instruments to obtain a higher yield for the same hedge.

The investment manager said that interest in less conventional hedges, such as swaptions, increased due to attractive market levels seen at the end of June.

Alex Soulsby, F&C head of derivative management, said: "Looking ahead, central bank policy will continue to be a key determinant of the level of hedging activity.

"The lack of quantitative easing combined with a large amount of upcoming index-linked gilt supply could weigh on the inflation curve and cause the price of inflation hedging to fall."

Regarding interest rates over the quarter, yields reached record lows but then Fed tapering fears caused a large rise in rates, F&C said.

While overall the interest rate risk traded over the quarter remained constant at £13bn of liabilities hedged, the rise in rates saw a number of schemes increase their hedge due to pre-arranged trigger instructions given to the LDI manager or market moves.

In Q1 2013, interest rate hedging activity represented £13.1bn of liabilities compared to £12.3bn in the previous quarter.

Soulsby said: "The possibility of the tapering of US Federal quantitative easing could see yields rise further, leaving further scope for interest rate hedging."

First published 26.09.2013

monique_simpson@wilmington.co.uk