UK - Increased pension fund demand could see the UK's inflation-linked swaps market exceed £9bn by year end, more than tripling in size, Watson Wyatt has claimed.
Kevin Carter, European head of investment consulting at Watson Wyatt, said: “As pension funds and their sponsors search for more effective ways to manage risk, they are realising that derivatives can alter the nature of that risk in ways that are not possible in the cash markets.
“In addition, there is a broad realisation that there is a variety of derivative instruments that can provide pension funds with protection, enhanced performance and a better match for liabilities.”
Watson Wyatt said the main attraction for pension funds was that inflation-linked swaps can increase efficiency in the portfolio while also reducing risk.
They also increase pension funds’ choice of investment options because they achieve exposures that are not possible through the use of physical securities, the firm added.
Yet Carter cautioned “there are some very important questions funds need to answer before entering these strategies.”
These include legality for use by the fund, pricing transparency in the product, whether the entity selling the solution has the appropriate product and can manage the collateral and whether the product will do what is expected.
“Subject to answering these satisfactorily, pension funds can confidently consider entering a structured product strategy,” he said.
Watson Wyatt said that the size of the UK inflation-linked swaps market in 2004 for end users was estimated to be at around £3bn.
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