Royal Mail Pension Plan has invested £700m in an options mandate, as schemes increasingly turn to derivative-based strategies to reduce risk while seeking growth.
Derivatives offer schemes the possibility to reduce potential risk, without necessarily needing to pay for it up front. Using such strategies are the preserve of larger funds, consultants say, as access is limited for smaller schemes.
Royal Mail appointed asset manager River and Mercantile to manage the options mandate, which RMPP’s chief investment officer Ian McKnight described in a statement as “part of our ongoing risk-mitigation investment strategy”.
The mandate will use a structured equity strategy to manage equity risks.
We’re seeing quite a lot of interest, and that’s going up
Jenny Yoe, River & Mercantile
Late last year, the Royal Mail scheme substantially increased its use of swaps and introduced gilt repurchase agreements, with swaps hedging 56.7 per cent of the liabilities, and repos hedging a further 21.8 per cent.
This compares with 2013 when swaps hedged just 24.5 per cent of the portfolio and there were no repos.
Managing downside
Jenny Yoe, managing director of UK institutional for River and Mercantile, said UK schemes were increasingly looking at structured equity mandates for their growth portfolios.
“We’re seeing quite a lot of interest, and that’s going up,” she said. “There’s another big scheme in the pipeline at the moment.”
Yoe added the manager had set up more than 110 options mandates over the past decade.
Mark Davies, managing director at River and Mercantile, said structured equity strategies aimed to provide exposure to equity markets, with protection if things go wrong.
“Generally speaking, it sits in the return-seeking portfolio,” he said, adding that it was challenging to manage the conflicting objectives of getting return on one hand versus managing downside.
LDI
As well as structured equity, pension schemes also use derivatives in liability-driven investment strategies as part of their derisking efforts.
Robert McElvanney, principal investment consultant at Aon Hewitt, said: “There are some pension plans or sponsors that are still getting comfortable with the idea of using derivatives,” but added most are “pretty comfortable, as evidenced by the amount of LDI.”
Consultancy KPMG’s most recent LDI survey showed the amount of liabilities hedged was at £517bn in 2013, up £74bn on the previous year.
But Simeon Willis, principal consultant at KPMG, said that despite this, many derivative arrangements were still unavailable to smaller schemes.
“They’re still a larger-scheme solution,” he said. “Pooled funds are harder to construct using derivatives. Often mandates tend to be segregated because of the challenges of wrapping into a pooled mandate.”
Willis added the pricing of derivatives often meant the cost of buying protection was higher than the amount that could be made by selling outperformance.
“With equity options, the normal environment is that it’s more expensive to buy protection,” he said. “If we did do [a] collar where we buy upside and sell downside it’s skewed – the price of the options is asymmetrical.”
