Insight Investment under fire for swaps strategy

Abdallah Nauphal, Insight

Four consultants told Financial News that the decision by the manager, which carries out switches on regular occasions to offset the costs of its hedging strategy, has meant their clients have suffered because an unexpected gain in the value of swaps. Gilts have been 60 basis points cheaper than swaps through much of this year.

The losses surprised clients, given Insight is highly regarded for its expertise in LDI, used by pension schemes to achieve a close match between their assets and liabilities. It has been voted top LDI provider in the Financial News awards for excellence six years running.

One consultant said: “Insight actively allocates the assets which cover liabilities and charges a performance fee for the service. It’s done well for a long time, but it’s lost so much ground over the last year our gains have been wiped out.

“It’s too early to conclude how this will work out. All I know is if we realise our investment now, we will lose money.” He said losses were exaggerated by the large size of LDI mandates, often worth billions, plus the scale of gains and losses which can be incurred by small price movements when yields are low.

Another consultant said: “Insight bet too much on black, and kept the bet in place, even when the market moved against them. It’s a situation we’re watching closely.”

Insight chief executive Abdallah Nauphal responded by saying the gap between the value of gilts and swaps had been “unprecedented”, while adding it has recently narrowed. He said gilts still offered the best value.

Nauphal said: “It is a good arbitrage situation. And arbitrage is the safest strategy in current market conditions.” He said Insight also spread its bets.

“Our view is that if there are inefficiencies in the market you should take advantage of, you should do so. I would not call this active management, but we have sought to cheapen the cost of the hedge by allocating between different instruments.”

Nauphal also said investors across the capital markets needed to be prepared for sudden shocks when prices move sideways for a long period of time, until overdue adjustments suddenly occur.

“The market is less liquid in general. You can’t trade quite so easily. The risk appetite from banks has gone. Even currencies are less liquid. You can get a sudden price change overnight, rather than prices changing gradually. It’s like hitting an air pocket.”

Nick Buckland, head of treasury and pensions at Dorset County Council, said he retained faith in Insight: “We are aware that the discretion that Insight have in managing our portfolio has led to some short-term underperformance, but we fully understand what has driven the performance and understand that over the long term this will not be an issue.”

Two pension schemes also said they were aware of losses on Insight’s LDI portfolios. Nauphal said there has been a very small number of switches out of Insight’s active strategy into a passive strategy.

Consulting firm P-Solve declined to comment on Insight, but it has argued that several factors have been working in favour of swaps, and might continue to do so.

One of its research notes published in February 2016 pointed to the scale of the problem: “If a currently fully-funded scheme measures its liability with gilts but matches it with swaps, then a gilt/swap spread of 60 basis points could lead to it finding itself, after three decades, with a deficit 15% higher than expected.”

The price of swaps has been driven up by banks using them for hedging purposes, rather than gilts, which they traditionally used as collateral for borrowings through gilt-repo trades.

Regulators are requiring banks to hold more capital against the transactions, pushing up their cost and persuading them to use swaps instead. Insurers are also using more swaps to hedge their liabilities, as a result of the European Union’s Solvency II directive.

According to P-Solve, the switch to swaps has also accelerated, as a result of insurers using them to finalise pension scheme buyouts. However, Nauphal said the banks were mainly responsible for the swaps surge.

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