The true impact of the liability-driven investment turmoil will only be known when schemes start publishing their annual accounts, especially for a group of pension funds that were not able to meet collateral calls and lost their hedges, the Pension Protection Fund’s head of LDI and credit has warned.
Speaking at a Pension Playpen event on November 29, Evan Guppy noted that there is a “tail of schemes that weren’t able to put capital in to maintain their interest rate and inflation exposure exactly [...] when they should be looking to increase their hedges”, and the true impact will not be known “until we start getting the annual accounts for these schemes in the next 18 months or so”.
The Bank of England announced a £65bn bond-buying programme on September 28 in an attempt to stabilise markets, after falling government bond prices prompted collateral calls for pension funds.
This intervention followed the so-called “mini” Budget on September 23, which saw falling government bond prices prompt a series of collateral calls from DB schemes that some feared would lead to a “doom loop” that would crash the market.
If we thought the minimum level of liquidity is 200bp and we can change our investment strategy if we need to in two or three days, if schemes have a decision-making process that is a lot slower than that, then they need to have a much bigger buffer
Evan Guppy, Pension Protection Fund
Issues arose specifically around pension funds’ LDI strategies, designed to protect against falling interest rates. Most schemes had conducted stress tests for a scenario in which there was a 1 per cent rise in long-term gilt yields, but the 4 per cent rise exceeded the contingency plans of several, prompting the BoE’s intervention.
There has been some dispute as to the true severity of the crisis. Several industry experts were quick to reject the suggestion that there could be a widespread collapse of pension funds, and the Pensions Regulator — which some felt should have been more proactive in addressing LDI and its role in the crisis — suggested that most schemes had “sensible waterfall measures in place” to face collateral calls.
Schemes look to top up liquid assets
Guppy predicted that the crisis impact “is going to continue to reverberate around asset markets for maybe another six to nine months”, as schemes will now try “to sell some of their holdings in private assets to try and top up some of these liquid assets”, which were sold in the past months.
He explained that schemes had a pre-warning to the crisis in June, when “a lot of the LDI pooled funds recapitalised”.
Pensions Expert reported at the time that consultancies Aon and Mercer were urging pension schemes, trustees and sponsors to prepare to intervene to protect their schemes as bond market volatility was impacting LDI strategies.
“We’ve had two very decent rounds of deleveraging, so even for those schemes that didn’t end up losing their hedges in either June or September, if we get another surge in yields and another call for capital to deleverage LDI pooled funds, they might have used up all of the liquid assets that they have left available,” Guppy noted.
Business as usual for the PPF
While there are reports that investment managers have reduced leverage within pension schemes, and schemes are holding higher buffers of collateral to meet calls from managers, Guppy noted that decision-making within pension funds is still “relatively slow”.
The pensions lifeboat has a LDI allocation to hedge against interest rate and inflation risks, while setting a minimum for its collateral buffer to face a 200 basis points rise in gilt yields.
Pensions Expert reported in October the PPF met £1.6bn in collateral calls and has no intention of reviewing its investment strategy and its use of LDI.
“If we thought the minimum level of liquidity is 200bp and we can change our investment strategy if we need to in two or three days, if schemes have a decision-making process that is a lot slower than that, then they need to have a much bigger buffer,” Guppy noted.
Experts estimate £500bn in assets are ‘missing’ after LDI crisis
Around £500bn in pension scheme assets are “missing somewhere” as a result of the liability-driven investment crisis, the Work and Pensions Committee has been told, with experts also questioning the role of leverage in these funds and the need for more guidance from regulators.
He detailed the work done by the lifeboat fund’s in-house investment team in 2022, when it had “been reallocating assets from other asset classes into the LDI portfolio through the first half of the year, certainly into June when yields were starting to rise”.
The goal was “to make sure we did maintain the level of liquidity that we thought we needed and then some – we entered the September period in a good place”, he added.
The PPF was even able to take advantage of the assets sell-out, Guppy revealed. “During September and October, while some schemes were rushing to try and raise collateral we were in a fortunate position where we were able to look for opportunities […] for us to increase our allocation.”
