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Hedging interest rates and inflation
11 March 2014
Investors are looking to source investment-grade floating rate notes because they are worried about rising interest rates, according to Investec's Harris Gorre
Investors are increasingly searching for investment
opportunities of greater than one year that hedge against
interest rates and inflation, according to Investec Impala.
Harris Gorre, head of new financial products, said that
clients are looking to source investment-grade floating rate
notes because they are worried about rising interest rates and
investment grade corporate inflation-linkers to alleviate
However, many corporates have no requirement to issue either
floating rate note (FRN) or inflation-linked bonds. "This
creates an unnatural shortage in the market, especially in the
UK, where gilt futures provide for an imperfect duration
hedge," said Gorre.
There are options available that offer inflation-like returns
such as infrastructure, commercial property and private equity
but Gorre said these are often illiquid and can be risky.
"One of the reasons defined benefit pension schemes are buying
these assets is because there are not enough inflation-linked
bonds, which easily offset the risk," added Gorre.
Insurance companies are heavily long in bonds and have a dearth
of attractive opportunities, given the fact that most FRNs are
issued by banks in the three to five-year maturity and pay a
very low coupon. "This does not address their yield or income
requirements," said Gorre.
The expectation of rates longer than one year has been
gradually shifting upwards with the expectation of 3ML over the
next 10 years doubling from 1.49% to 3% in 2013, which Gorre
noted was a poor year for insurance companies because their
investment portfolios lost money. "If they bought a bond when
the expectation was 1.5% then they have effectively lost
capital value on that bond," he says.
Gorre expected more innovation around duration and observes one
interesting development of closed-end exchange traded funds in
the US. "A closed-end ETF offers the value of inflation at
maturity and if it takes off in the US then we could see
similar innovation in the European market."