Everyone hates to admit they are wrong. This simple observation has been given academic rigor in the behavioral theories of loss aversion, regret aversion and the sunk cost fallacy, among others. If you have lived with a view that yields are too low and expressed that view by not hedging, it is awfully hard to change now. This has been prevalent since liability-driven investing really got going over a decade ago.
Any pension fund trustee who chooses to hedge liabilities today faces challenging questions: why now; why not before; won't things get better?
If we are to really tackle the challenges facing pension plans, we must first acknowledge that the real issue is not one of measurement or methodology. What we do need, however, is an amnesty on risk management. The Pensions Regulator should draw a line and provide clear guidance that a single, poorly diversified view on how interest rates will perform vs. market expectations is not appropriate for trustees to make. Regret risk should be taken out of the equation: you will not be judged on the financial outcome of a decision that was taken with the reasonable intent of risk management.
At the same time, it is right that investors should retain the flexibility they have today to invest in and exploit opportunities consistent with their long term time horizon and the individual circumstances of their scheme. The opportunity set is large, including other fixed-income assets in both public and private markets and high-quality real estate and infrastructure assets. All can provide secure, predictable income streams to meet pension liabilities.
The U.K. Pension Protection Fund and large corporate pension plans have clearly demonstrated what can be achieved with a simple, transparent investment philosophy, even at a very large scale. The solution is not science or new; it is common sense: mitigate poorly rewarded risks, invest for the long term and seek out attractive investment opportunities to outperform liabilities.