State Street Global Advisors has set up a novel inflation fund to offer more efficient inflation hedging to pension funds. Other major money managers, including Fidelity Investments, are thought to be hot on its heels. The fund, known as a pooled-fund vehicle, is believed to be the first of its kind for the inflation market. It works by entering sterling limited-price indexation inflation swaps in which the fund receives inflation exposure across the curve, up to 40 years, and pays a floating interest rate. Pension funds can then hedge their exposure to inflation by taking exposure to the mother fund.
The vehicle offers pension funds exposure to a range of sterling inflation swaps with a cash-management component. It is a tax efficient structure that is often used in other asset classes by international corporates with pension funds in different countries, or by small- and medium-sized funds who want to pool assets for economies of scale. Joe Moody, principal in global fixed income at State Street in London, said the fund also appeals to larger clients who are considering investing in the fund to diversify their portfolio.
Moody believes the sterling inflation market is now liquid enough to support a pooled institutional product. State Street is also looking at offering a similar vehicle for the euro market. More of these deals are likely to go ahead, said a rival investment manager. "Fund managers are looking at alternative types of inflation protection," added the rival, who noted that increasing liquidity will aid product developments, such as inflation caps and floors and options (DW, 9/17).
The last month has seen a change in the character of the sterling inflation market. Traders said deals were previously large and sporadic, but are now more frequent and in more moderate sizes. Alan James, director in global inflation-linked research at Barclays Capital in London, said, "There has definitely been a significant increase in trades." At the front-end of the curve the liquidity of the swaps market is being boosted by more balanced flow, for example, from utilities paying inflation, while the back-end is being boosted by growing numbers of institutional investors, explained James.
