UK - State Street Global Advisors (SSgA) has brought to market its Pooled Asset Liability Matching Solution (PALMs) - a series of pooled vehicles which allow UK pension funds to match future liabilities in different inflation environments.
The new product provides access to nine pooled funds holding Limited Price Inflation swaps (LPI, or inflation-linked securities) of different maturity, to protect assets and preserve pensioners’ purchasing power in both high and low inflation environments.
Pension funds with varying liability requirements can purchase different allocations of the nine funds, which are divided into five-year increments reaching out to 40 years, that individuallydeliver annual cash flows when they are needed.
Based on SSgA commissioned research, there are some £70-100bn in pension liabilities linked to LPI, by virtue of UK pensions law where schemes are either linked to RPI or LPI.
Investing in the SsgA Liability Matched Pension Funds is effected by means of a unit-linked insurance policy written by Managed Pension Funds Limited (MPF Ltd.), a member of the State Street Group.
Eight of the pooled funds hold the different maturity, zero coupon LPI swaps, and the ninth fund will be a cash pool, generating three month LIBOR.
The collar position , whereby LPI swaps are created from standard UK RPI swaps, with added protection against deflation and a cap on the sale of inflation rights, means that the investor receives zero return in the case of deflation, the RPI return if inflation is between 0% and 5% and a 5% return if inflation exceeds 5%.
Additionally, the flexibility of the underlying structure of PALMs allows pension plans to adopt different liability matching strategies and re-spend the pension funds’ risk budget for more reward. For example, a pension plan can choose to incorporate alpha-generating strategies such as the use of credit markets to add extra yield.
In essence, the pension fund can swap inflation risk for credit risk or, put differently, buy inflation protection and sell credit protection with the aim of generating alpha through the CDS markets.
“PALMs represents a generational change in investment management strategy for pension plans,” said Alan Brown, group CIO for SSgA.
“By recognising that liabilities, not market benchmarks, are the correct measure of a pension plan’s ability to meet its obligations to pensioners, we can more closely match the client’s liabilities over time, reducing the risk of over - or under - funding. We expect this concept to grow in popularity because it places more investment control back in the hands of trustees.”
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