My blog: 26 July 2005
You’ve probably heard it before, but it bears repeating. It’s the 1978 Masters, Augusta, and after striping a drive down the middle of the 10th fairway, Gary Player hits a 5-iron and then makes an incredibly difficult 25-foot side hill putt.
So difficult, everyone is convinced he’s missed until, at the last moment, the ball trickles in. They don’t come any luckier than Gary Player, suggested a journalist at the Press conference after the match.
“Yes“, agreed Player. “And the funny thing is, the more I practise, the luckier I get.”
In 2003, many pension schemes recognised they were exposed to rising inflation expectations and falling interest rates – in other words, a contracting real yield. But with the real yield then at 2.20%, they made two crucial mistakes – first, they decided the real yield would not fall much further and second they took the view that they could afford to be wrong. With the real yield now 73 basis points lower, that was an expensive decision.
Friends Provident looked at the real yield in 2003 and decided to hedge the risk. Not because they were convinced it would fall further, but because they had an established framework for risk management across the group and the pension scheme’s risk profile broke all the rules of risk budgeting. The Trustees agreed.
In December 2003, they hedged. As the real yield fell, the pension scheme’s liabilities went up. But so did the new hedging asset, offsetting the loss.
Some say they just got lucky. Maybe.