The first LDI Investment Solutions webinar of the year was hosted by Simon Bentley, Managing Director and Head of Solutions Client Portfolio Management, with presentations from Kazmen Lian, LDI Solutions Structurer at Columbia Threadneedle, and Nina Roth, Director, Responsible Investment.
The benefits of using ‘special bonds’ for repo transactions have increased. These bonds are in demand at counterparty banks, and they include those with maturities up to 10 years and those that mature in 2050. If you post these bonds as security against your repo borrowing, you generally get a much better rate.
With the majority of our LDI portfolios, we aim to allocate towards the cheaper of gilts and swaps, but we also aim to create value by switching between them. Recent volatility has helped our strategy.
At the beginning of the year, gilts cheapened relative to swaps, driven by expectations of a flood of UK government bonds coming to the market and a rise in pension buyout activity, which bolsters demand for swaps.
The war in Ukraine prompted a flight to quality, which has increased demand for gilts and led them to outperform swaps since the end of February. Despite this, we still expect gilts to underperform swaps in the medium term, given the elevated levels of gilt supply anticipated by the market.
Changes in LPI
We’ve seen large increases in both realised and expected inflation levels over the past year. In theory, as inflation expectations rise the inflation hedge ratio (where 100% is fully hedged) should increase. This is because the inflation sensitivity of the liabilities decreases, whilst that of the assets remains unchanged.
The analysis we have conducted suggests that inflation hedge ratios will generally have increased by 10-20%, all other things being equal, over the last year or so.
We have roughly 80 priority companies, with particularly poor environmental, social and governance (ESG) track records and controversies, which we must engage with regularly. We have thematic projects, usually about 10 each year, where we engage to try to improve specific practices. And we also have event-driven engagement, often before annual shareholder meetings, when we make our views and voting intentions clear.
Climate change and banks
Over the past nine months, most of these banks have announced commitments to have net-zero-emissions financing by 2050. We want to look closer at these commitments, making sure they are credible and well implemented.
Initially, we will focus on 10 banks over two years, eight of them from developed markets and two from emerging markets. We want them to include underwriting, off-balance sheet activities and deforestation in the way they assess their emissions.
We don’t always act alone. We also collaborate with other investors, and with organisations including the Institutional Investors Group on Climate Change and the Asia Research and Engagement Energy Transition Platform.
We have dedicated engagement ‘asks’ for our LDI counterparties. They are similar to our wider ESG focus and include climate-risk management, strength of governance and robustness of reporting and disclosure.
More banks have confirmed that their boards now have some level of climate-change or ESG responsibility, although it does not tend to be linked to performance incentives.
Banks do broadly perform climate-change stress testing and scenario analysis, but this tends to be limited to a region or a sector, meaning they ignore a lot of their risks. In terms of their commitments, they tend to focus on their lending and project financing activities, and we think they should be thinking about all capital markets.
Most developed-market banks have frameworks in place ready for mandatory disclosure based on the Taskforce for Climate-related Financial Disclosures (TCFD), but as things stand there is little detail beyond lending.
Out of 26 engageable LDI-specific counterparties, we engaged with a total of 18 in 2021, and our 92 interactions have led to 19 milestones being achieved.