Schroder Investment Management has developed an alternative way of guaranteeing asset managers' portfolios while maintaining upside participation. John McLaughlin, head of structured investments, in London, said this method is cheaper and more flexible than using zero-coupon bonds and options and less path-dependent than traditional Constant Portfolio Proportion Insurance.
The pressure on pension funds to manage assets and liabilities more accurately and the increasing sophistication of asset managers should increase the use of derivatives in years to come, noted McLaughlin. The low-interest rate environment, however, will force asset managers to develop new structures to keep costs down, he added.
The structure, known as dynamic asset allocation, gives the pension fund 100% capital protection across different underlying assets. It uses short-term cash instruments, such as money-market products, and either interest rate or inflation swaps to provide the guarantee.
To provide the exposure to the underlying investments, Schroder, will create synthetic options using futures and delta hedge the risk itself, according to McLaughlin.
Other asset managers agreed that this structure could have benefits. Andrew Irvine, head of structured investment products at Investec Financial Products in London, said using money market instruments would make reallocation into the underlying flexible. The inflation swap protects against erosion of return on long-term positions, he added. Using futures to create synthetic options could be cheaper and more flexible than using over-the-counter options since futures are more commoditized. This would, however, only be the case when the futures market for that asset is sufficiently liquid, he noted.
Schroder developed this structure for a recent competition organized by the Universities Superannuation Scheme, a U.K. pension fund, and Hewitt Bacon & Woodrow, a U.S. consultancy, to find the best way to manage money in a long-term and socially responsible way. Henderson Global Investors won the competition.
