Liability surrogates can be attractive – but don’t surrender to the sloths!

March 26, 2013 Categories: Investment Strategy
Russell Investments Wire risk to liabilities

With real interest rates incredibly low, investors are seeking better ways of liability driven investment than just buying more gilts. One option we have been exploring for clients is “liability surrogates”.

Liability surrogates are an emerging group of assets which can undertake a similar role to index-linked gilts but provide a more attractive return than the current negative real yields. Liability surrogates offer a very long term, steady contractual stream of inflation-related cash flows, where most of the return comes from income. They are expected to have a higher return than index-linked gilts, but the extra return should come predominantly from their lower liquidity rather than from risks to the underlying income payments.

There is no simple dividing line between liability surrogates and return seeking assets, and as the quality of the link with inflation and security of income drops, then the returns would be expected to be higher and they become increasingly similar to other return seeking assets.

At the NAPF conference in Edinburgh the other week, Crispin Lace and I held a workshop on liability surrogates. A copy of the presentation can be found here along with a short introductory paper. We touch on the key factors within the presentation during which we wanted to show that liability surrogates:

  • exist, and can provide attractive opportunities;
  • are typically based on real assets which means that each one is different and idiosyncratic;
  • include appropriately structured Social Housing and Infrastructure Debt which look particularly strong candidates; and
  • can provide elements of both growth and matching assets.

However, the key message we wanted to convey during the workshop was “Beware of the Sloths”. We are not used to investing over the long term and inflation related payments can have significant compounding effects.

Often we see in the press simple comments like: “It’s a no brainer. Why don’t all pensions funds get off their backsides and invest in XYZ.” In practice, nothing is that simple. We think there are some excellent opportunities – but these need to be scrutinised very carefully. Surrogates role in the portfolio, and their risks, need to be understood in detail. Our presentation looks to highlight some of these key issues.

I don’t think this work nor its potential is complete and I’d be very happy to explore further with you the existence, use and scrutiny of this emerging asset class.

Nick Spencer, Regional Alternative Consulting Director, EMEA

  1. No comments yet.
  1. No trackbacks yet.

This blog is not intended for retail investors. The opinions expressed herein are that of Russell Investments, are not a statement of fact, are subject to change and, unless they relates to a specified investment, do not constitute the regulated activity of “advising on investments” for the purposes of the Financial Services and Markets Act 2000.

This material does not constitute an offer or invitation to anyone in any jurisdiction to invest in any Russell product or use any Russell services where such offer or invitation is not lawful, or in which the person making such offer or invitation is not qualified to do so, nor has it been prepared in connection with any such offer or invitation.

Unless otherwise specified, Russell Investments is the source of all data. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate.

The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

Copyright © Russell Investments 2018. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

The Russell logo is a trademark and service mark of Russell Investments.

Issued by Russell Investments Limited. Company No. 02086230. Registered in England and Wales with registered office at: Rex House, 10 Regent Street, London SW1Y 4PE. Telephone 020 7024 6000. Authorised and regulated by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS.