Liability surrogate assets recommended for current market conditions

December, 2012 Print

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Russell Investments has advocated the use of assets which are liability surrogates in the place of traditional liability hedges, given the low sovereign bond yields in many European countries.

 It said that long lease property, ground rents and social housing, as well as mature infrastructure assets, make good liability surrogates. These assets might not precisely match a liability stream, but should reduce funding volatility and are cheaper than sovereign bonds. Russell Investments senior consultant Lloyd Raynor commented: “Pension funds typically have return-seeking portfolios to outperform liabilities and hedging portfolios to closely mimic their movement. Liability surrogates sit between the two. As with returnseeking assets, the aim is still to outperform the liabilities, but to achieve such outperformance with lower tracking error relative to the liabilities, to dampen down funding level volatility. In this sense they may be considered a partial alternative to traditional hedging which remains out of reach for many given its expense.”
 Raynor added that liability surrogates should also hedge against inflation, as their spread over indexlinked Gilts should help them outperform over the long-term. He stated: “At a time when many pension funds are unable to implement traditional liability hedging strategies due to their expense, liability surrogates may offer an attractive alternative. However, funds should be sure to harvest a suitable premium for the often high levels of illiquidity involved.”

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