Kingfisher ups hedging level as scheme slips into surplus

The amount of UK liabilities hedged through liability-driven investing grew by 13 per cent over the year to June, according to consultancy KPMG, despite LDI coming under renewed scrutiny in a fiery exchange of industry blogs.

Even if you’re well hedged on technical provisions, you’re probably still quite underhedged relative to buyout

Rod Goodyer, Barnett Waddingham

While the £2.9bn Kingfisher Pension Scheme’s funding level of 99 per cent on a technical provisions basis is no higher than at its 2013 actuarial valuation, its experience is in stark contrast to the ballooning deficits of other schemes seen over the summer.

In the months since its actuarial valuation in March, the scheme noted that “the funding position has improved such that there was no technical provisions deficit at the time of signing off the valuation”.

The next step: Full funding on a gilts basis

Having begun to derisk in 2004, the scheme’s hedge ratio now stands at 87 per cent of its exposure to interest rate and inflation sensitivities.

“The hedging has helped during periods of global market volatility, for example, the scheme’s funding level improved post Brexit,” said Dermot Courtier, head of group pensions and secretary to the trustee at Kingfisher.

The scheme is working towards a secondary funding objective, whereby it will reach full funding on a gilts basis by 2030. On this basis, the scheme’s funding level in March 2016 was 82 per cent.

Its derisking programme has been wide-ranging, comprising medically underwritten annuities, the introduction of triggers and diversification into the portfolio, and a cash plus approach to its investment grade credit allocation.

Source: KPMG/Purple Book

“Whilst we hope the economic and financial market environment is more positive for the second half of the Scheme’s journey, we are comfortable that we’re in good position to progress on our journey whatever challenges [lie] ahead,” said Courtier.

Still not fully hedged

Because Kingfisher is not fully hedged, its secondary funding deficit will still demonstrate some sensitivity to changes in market conditions such as gilt yields falling further.

“Even if you’re well hedged on technical provisions, you’re probably still quite underhedged relative to buyout,” said Rod Goodyer, partner and investment strategy specialist at consultancy Barnett Waddingham.

The current hedge ratio, he said, means that the scheme could still benefit from an unexpectedly fast rate rise, while Courtier pointed out that the scheme’s growth assets have tended to outperform liabilities during periods of falling rates.

Will hedging get cheaper?

Whether or not interest rates and gilt yields do rise may depend on future monetary policy and the government’s appetite for further monetary stimulus.

Prime Minister Theresa May hinted at an end to quantitative easing at the Conservative party conference this month, saying: “We have to acknowledge there have been some bad side effects.”

Conventional wisdom would dictate that monetary tightening would push up gilt yields, making LDI cheaper, but Goodyer warned that high demand from schemes for gilts might alter this: “There are a lot of schemes out there with triggers to buy gilts.”

It has been argued that this heightened demand, brought about by LDI, makes it even harder for schemes to achieve their funding goals.

BrightonRock Group’s head of research Con Keating recently called schemes that have reached full funding by managing their assets against their liabilities “the few that have profited from the protocol at the expense of their neighbours; these are the polluters who have poisoned the pensions environment for the world at large”.

But for Goodyer, calculating the present value of liabilities aids scheme objectives due to its links to the insurance industry.

“At the end of the day most schemes would like to ultimately buy out, in which case this is consistent with how insurance companies measure the liabilities,” he said.

Dan Mikulskis, head of defined benefit at consultancy Redington, said interest rates are an emotional subject: “In our discussions with many schemes and stakeholders we’ve consistently found that interest rates is an issue around which there are strong emotions, views and biases.”

He said schemes should approach derisking by assessing their long-term objectives, and should not be drawn into short-termism over policy announcements.

“We would encourage schemes to adopt a risk management mindset, and not be focused on specific announcements or market events as drivers of their decision-making,” he said.