Cadbury hedges fifth of assets to manage risk

The £2.3bn scheme’s new liability-driven investment strategy is designed to mitigate the risk of lower interest rates, which could feed into lower investment returns. In addition, higher inflation could increase the cost of future benefits.

"During the year, the trustees took extra steps to ensure the investments they hold take into account the risks which could affect the cost of the fund’s liabilities," the scheme told members in its April 2013 newsletter.

A slump in the value of hedging instruments has left schemes in a quandary about whether to settle for more expensive hedges.  Phil Page, client director at Cardano, said schemes should consider three factors in setting their minimum initial hedging level:

• The amount of funding level risk;

• The size of those risks compared to other investment risks such as holding equities;

• How close current hedging market prices are to perceived fair value.

"The minimum initial level of hedging, which recently has been at least 40 per cent of assets, will usually differ based on the strength of the sponsor covenant and the trustees’ attitude to shorter term risk," he said.

The Cadbury scheme had a funding level of 79.1 per cent in April 2012, down from 86.2 per cent two years earlier. It is planning to achieve full funding by the end of March 2019, with the company currently paying £30m a year in additional contributions.

Schemes that have held out against perceived expensive hedging rates may have suffered as rates continued to fall over the past few years, said Karen Heaven, vice-president in investment consulting at Redington.

“One [answer] is to implement a fixed amount of hedging regularly, in order to increase the hedge ratio and reduce the regret risk of hedging at any one particular time,” she added.

A spokesperson for Mondelez, which owns the Cadbury brand, declined to expand upon the information contained in the scheme newsletter.