IC Select founder Roger Brown details how schemes should analyse the advice and asset management received during the liability-driven investment debacle.
Resurgent inflation, rising interest rates ,and Russia’s invasion of Ukraine had already led to dramatic volatility in bond and equity markets, before an abrupt shift in UK fiscal policy caught investors by surprise and made matters worse.
On September 23, the Truss government’s “mini” Budget promised a programme of sweeping tax cuts unbalanced by any reductions in spending. Gilt yields surged in response, with immediate consequences for many defined benefit pension schemes.
Over the past two decades, DB schemes have widely adopted liability-driven investment to sustain and improve their funding levels.
Independent oversight of these events can improve trustees’ confidence in their investment strategy, and help to assure them that their fund will be sufficiently resilient when the next crisis strikes
Many LDI products hedge against the prospect of falling gilt yields, which increase schemes’ liabilities, and most employ leverage to boost exposure to gilts as matching assets.
Although LDI strategies generally held up well during the 2008 global financial crisis, the events of 2022 – catalysed by the “mini” Budget – put them under severe strain.
As gilt yields soared, the underlying LDI funds experienced margin calls, forcing DB schemes to raise collateral to meet them. This was typically achieved through selling gilts, putting further upwards pressure on yields.
The resultant havoc put some schemes at risk of serious loss, possibly even failure. Eventually, the Bank of England was forced to intervene by restarting its gilt-purchasing programme.
How did your scheme cope with the crisis? A checklist for trustees
How did your adviser or fiduciary manager perform during the LDI crisis?
How did this performance compare with their peers?
Was the scheme able to maintain its LDI hedge?
How involved did you as trustees have to be?
Was the decision-making process efficient?
Has the cost of the crisis had an impact on performance?
Where did this occur, and why?
Was this avoidable?
How did you rate the communication you received?
Did the written reporting answer your key questions?
Did you receive additional communication during the crisis?
Are there any aspects of reporting and communications that need to be enhanced?
Has the LDI turbulence increased or diminished your confidence in your adviser or fiduciary manager?
What are the learning points and implications for trustee governance?
Delegating more, or possibly less of the investment complexity?
Is there a need for trustee training? Additional reporting of certain risks?
Lack of clarity
The performance of pension funds varied widely in this period of upheaval. Some came through almost unscathed. Others either suffered reduced LDI hedging positions or were forced to change their objectives to maintain it.
The lack of clarity around the LDI experience for many makes it difficult for pension fund trustees to assess the quality of the advice or fiduciary management they have received.
That is why oversight of advisers and fiduciary managers is so important, including the monitoring of performance, resources and risks.
So how should trustees set about assessing whether their advice or asset management was optimal? We believe that there are key points to consider.
Benefits of independent oversight
In turbulent times like these, the benefits of formal, independent oversight come sharply into focus.
When markets are more orderly, independent oversight of advisers and fiduciary managers can often be seen as a luxury. But it greatly helps to answer the questions that trustee boards should be asking in the wake of the LDI crisis.
Once the full picture becomes clear, funds with appropriate oversight should be well equipped to establish whether their experience in this crisis constitutes best practice, or whether their fund suffered unnecessary impacts. On top of this, the full performance cost for the fund can be independently verified.
Now that most of the “mini” Budget has been reversed, the initial phase of the LDI crisis may have passed.
But independent oversight of these events can improve trustees’ confidence in their investment strategy, and help to assure them that their fund will be sufficiently resilient when the next crisis strikes.
Roger Brown is a founder of IC Select
