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How important is safety for your matching portfolio?

Safe interest hedges are a vital necessity

Eleven years after the fall of Lehman Brothers, crisis indicators are deep in the red. This is the time for pension funds to resist the temptations of taking too much risk. A safe haven is paramount.

By Pim van Diepen, Director Business Development at Cardano.

Resist temptations

We cannot predict the future, but we do know that the financial system is fragile. Are we, more than 11 years after the fall of Lehman Brothers, approaching a Minsky moment? That moment when a seemingly stable situations turns into a major crisis? We don’t know, but the fact is that several crisis indicators are in the red. We are approaching the end of the economic cycle and we have long since reached the end of the long-term debt cycle – with debt accumulation currently at unprecedented levels.

Asset risk buildup and inflation have now skyrocketed, due to extremely low interest rates and an abundance of liquidity. So why not opt for Italian government bonds instead of Dutch or German ones, for example, to hedge the interest rate risk? They may be a little more risky, perhaps, but they’re government bonds and therefore safe. Right?

These are exactly the temptations you should resist. All interest rate hedges must contain a robust core matching portfolio, free of complexity and safe under all kinds of challenging economic conditions. A safe haven, based solely on safe government bonds and interest rate swaps. It will always be your strategy’s main objective to create a safe haven for the pensions accrued by your members.

More complex instruments

So, should you never include more complex instruments in your interest rate hedge? That’s a bit too simplistic. Depending on your situation, you can deploy more complex instruments in addition to your matching portfolio to target higher returns, such as mortgages, WSW loans and covered bonds. Whether this is a good option or not depends on three things: expertise, maturity and your pension fund’s financial position.


If you have the experts, you’ll be in a better position to implement a strategy involving more complex instruments. If your capacity and in-house expertise is more limited, the board must be able to focus on high-impact issues, especially during a crisis. They should emphasise the balance sheet strategy, return portfolio and managing outsourcing relationships, rather than wasting time on any hidden risks in the hedge.

Maturity and financial position

The maturity of your pension fund has an important role to play. Young funds can focus more on illiquidity, whereas older funds will emphasise liquidity.

Naturally, your fund’s financial position is another important factor: if your funding levels are so high that you can already guarantee all liabilities, including future indexation, a hedge will quickly cover a much larger part of the balance sheet. This will automatically require a wider range of instruments to help hedge inflation risks and ensure proper diversification. This may involve diminishing the return and risk profiles across the entire balance sheet, whilst adding more categories to the hedge.

The future

Ideally, you should already be thinking about how to structure your portfolio when funding levels are significantly higher. You want to trace out a path to that situation, and both theory and practice have taught us that, ideally, you should think about and outline important future decisions in advance. This contributes to de-biasing and substantially improves the quality of decision-making when the time finally comes.