Managing Volatility and Inflation: Strengthening the UK’s Lifeboat Fund with Continuous Rebalancing

The £31.2 billion Pension Protection Fund runs one of the UK’s largest LDI portfolios, built around a highly sophisticated internal operating strategy that is more akin to a bank’s ledger than a pension fund.

The Lifeboat Fund, established in 2005 to manage private sector defined benefit pension funds of distressed employers, splits its portfolio roughly 50/50 between debt hedging and growth allocation. The hedging allocation actively hedges 100% of its interest rate and inflation risk, meaning that exposures are constantly rebalanced and the fund effectively rebalances its liabilities on a weekly basis.

This is a level of control that has proven essential during recent periods of high gold price and inflation volatility due to conflict in the Middle East and current political instability in the UK, allowing the fund to manage markets in real time and adjust its portfolio accordingly.

The team’s primary focus was on managing inflationary volatility caused by sudden shortages of key raw material supplies and rebalancing hedges by selling when inflation rises and buying when it falls, thereby generating better returns.

“The main area of ​​interest has been inflation hedging strategies,” said Barry Kenneth, chief investment officer. Barry Kenneth says our ability to dynamically rebalance is the result of having a dedicated in-house team managing our strategy and best-in-class systems to support it. “Compared to other insurance companies and pension schemes, we run a very dynamic hedging strategy with weekly rebalancing.”

But he says in every news article or tweet lately that pension funds have been rebalanced more often than that as the markets have wobbled.

The strategy is “close” because the sensitivity of the market to each twist and turn makes it difficult to form any opinion with strong certainty.

However, the team believes that the range of results seems to be narrowing as full-scale regional competitions become less frequent. Accordingly, Kenneth said market volatility will ease over time and LDI portfolio management will gradually return to focusing on the impact of rising energy prices, along with domestic issues.

Here he draws particular attention to the possibility of an inflation-adjusted wage agreement, but believes the weakening of the UK labor market over the past 18 months makes it likely that a wage agreement will be quieter this year.

This is one of the predictions that supports the team’s belief that the Bank of England, like other investors, is unlikely to raise interest rates aggressively, paving the way for monetary policymakers to resume rate cuts in late 2026 or 2027.

“The policy interest rate market price at around 4% at the end of 2027 seems too high for us.”

Although less volatile than inflation, gold bonds have experienced levels of volatility not seen since the 2022 mini-budget crisis. But Kenneth says current levels are inconsistent with the period when many LDI investors in swaps were scrambling to secure enough eligible collateral to cover margin calls.

Today, he says, there is no such risk.

Gold bond yields have risen sharply since early March, but the biggest moves have been in shorter maturities, which are most sensitive to changes in interest rate expectations. The 20-year yield (a better approximation of LDI holdings) is up about 0.50% and remains below its last high.

“This helps explain why there are no signs of market tension in the repo market or in terms of collateral availability for margin calls. These movements are well below the 2.50-3% scale used by the pensions regulator and the Bank of England for stress scenarios.”

The strategic asset allocation of the matching portfolio is debt hedges (70%) and long-term credit (30%).

Investment performance

With a 50% allocation to growth, PPF is actively seeking opportunities in short-term fixed income where Kenneth believes there are opportunities to purchase at attractive yields.

The team also continues to maintain a positive view on risk assets and currently has some weight in its 8% strategic allocation to capital.

“This is a theme we believe will remain key in the coming years as investors navigate geopolitical trends and new macroeconomic policy shifts and seek diversification across geographies and asset classes where active security selection can add value.”

Nonetheless, Kenneth acknowledges that things are very different today. The main reasons are weak economic activity, low wage growth and a much looser labor market. This is an outlook that reflects the House’s view that the central bank is unlikely to embark on another hiking cycle and its belief that any major adjustments to the portfolio would be unwarranted.

Alternative Inflation Links

About half of the growth allocation is invested in alternatives covering private equity, infrastructure, farmland and agriculture through single transactions and co-investments and funds. Infrastructure and forest land provide another important inflation hedge because their value and inflation-linked income streams are directly linked to real economic activity.

“Real assets have historically been positively correlated with inflation and have a low correlation with traditional stocks and bonds, making them an effective hedge and stabilizing diversifier in investment portfolios,” he says.

With UK pension funds under pressure to invest more domestically, infrastructure, housing and growth assets are also seen as investments in UK production finance. The Mansion House Accords require the government to allocate at least 5% of pension fund assets to UK private markets as part of a plan that hopes to invest billions of dollars in UK businesses, infrastructure and property.

Elsewhere, a new investor-led partnership has been formed between 20 of the UK’s largest pension funds and insurer Sterling 20. A more prescriptive scheme, the Pension Schemes Bill, is currently working its way through Parliament and would lay the groundwork for regulators to force DC schemes to invest in certain assets such as private equity, debt or real estate.

Kenneth sees a special opportunity in transition infrastructure and argues that the Iran conflict strengthens the long-term case for alternative energy systems that are domestically produced, electrified, and less geopolitically exposed at the convergence of security, cost, and climate goals.

“Emerging threats to critical infrastructure and maritime gateways, particularly the Strait of Hormuz, once again expose the strategic vulnerabilities associated with dependence on fossil fuels,” Kenneth said.

That said, he believes the energy transition will be impacted in the short term by higher costs across energy-intensive value chains, including aluminum and other critical materials used in renewable energy, grids and transmission. Moreover, he found that some countries responded to supply stress by expanding or shifting coal generation to maintain affordability and security.

“Rather than immediately accelerating deployment, these combined effects risk delaying some of the transition by weakening project economics, tightening financing conditions and complicating supply chains,” he concluded.

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