I recently watched this TED talk by Tim Harford on how frustration can foster creativity that made me think about regulation in pensions.
In the first example Tim talks about Jazz pianist Keith Jarrett being frustrated with the piano he was forced to use in a concert in Köln in 1975. He was so angry with the equipment that he almost refused to play. Thankfully for fans he didn’t and the concert turned out to be one of the most popular solo jazz recordings of all time. The reason it was so popular was that Keith Jarrett changed the way he played the piano to compensate for its deficiencies and which resulted in a different (and more popular) sound.
Tim also talks about Brian Eno’s use of “Oblique Strategies” to foster creativity in his artists. In that example he talks about how human beings will tend to favour the path of least resistance but Oblique Strategies, essentially enforced randomness and frustration which actually turned out to be a useful tool for stimulating artists in the studio.
I was reminded of this when I read this story which talks about the challenges of regulations and its impact on pension funds. Whilst I agree with the principles of the article (see my previous post on unintended consequences) I have also written previously on how the industry should also begin to think about solutions.
So rather than lobby to maintain the status quo (even though I agree that is the right thing to do) and follow the path of least resistance should we harness our frustration to try and be more creative with our solutions?
There are signs of such innovation with potential solutions around managing the reducing liquidity in the repo market (required as a way to use more attractively prices gilts to hedge liabilities rather than swaps) but this is still very much focused on trying to maintain the current approach for LDI.
How about another approach – let’s get physical with our LDI.
Conventional LDI is about investing in return seeking assets and using swaps and repo to provide liability hedging (physical growth assets synthetic LDI). As you will see from the referenced pieces, there are challenges with this approach.
Another way to think about it could be to flip LDI on its head physical LDI and synthetic growth assets. What this means is that a schemes physical assets are invested in Gilts (gaining the benefit of holding assets with a superior yield to equivalent swaps) whilst accessing return seeking assets with derivatives (equity futures and options as well as credit derivatives for example).
Structured Equity is one of those approaches. There are a few benefits that may make it worth considering for some schemes:
- Owning physical gilts provides schemes with the yield pickup of gilts over swaps
- It does so without the roll risk of the Repo market
- The roll risk is transferred to equity derivatives which are based on a more liquid market
- Using equity derivatives allow pension schemes to shape their risk and return exposure
This may not be for everyone but for some schemes the frustration of regulation may actually result in them being more creative resulting in a strategy that is much better suited to their needs.