Investing for DB pension schemes

[Alaric]

Perhaps the real advantage is to the sponsoring company's balance sheet liabilities, not the pension fund?

That is mostly the point. Suppose you are 100% funded with 100% in equities. Almost overnight, equity prices crash 25% and nothing else changes. All of a sudden, your scheme is only 75% funded, on paper at least.

[ChrisNix]

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling. With QE rampant, and base rates on the path to zero, it was a great asset bet!

And a form of offset to the increase in the value of gilts which would have to be held to cash flow match outflows, a figure which many mistakenly refer to as the value of the liabilities.

This is the bit I don't really understand. OK, in a falling interest environment the value of fixed coupon investments would rise, so they could be sold down gradually at higher prices than bought to supply ongoing cash. But in such an environment so would the value of equities, and they probably would have a higher and rising dividend yield as well. So why the problem with equities? Volatility? But then, in a rising interest rate environment, bonds would fall in value as well as equities. I really cannot see the great advantage of the original, simple(?) liability driven (matched) investing (unless the bonds were held to redemption). Perhaps the real advantage is to the sponsoring company's balance sheet liabilities, not the pension fund?

This gives background: https://www.telegraph.co.uk/business/20 ... ays-fund0/

[Nimrod103]

And the next mystery is that Bailey should have been on top of this, was definitiely warned about it years ago, and should have stamped the practise out. He didn't, so he should be sacked.

But instead he is feted in Washington, and his pronouncements are currently all over the front page of the Telegraph as if he knows what he is doing.

[XFool]

This gives background: https://www.telegraph.co.uk/business/20 ... ays-fund0/

Ah, thanks. This gives some insight. So ultimately Maxwell is at the source of the problem - as with so many things to do with pension funds.

"Eight years after Robert Maxwell plundered the Mirror Group pension pot before his untimely death, the rules changed to force companies to provide greater transparency in relation to their retirement fund obligations. From then on, directors were forced to disclose gaping holes in company retirement funds."

And where there's a problem, there's a solution. For a price.

"Dawid Konotey-Ahulu, then a managing director at Wall Street investment bank Merrill Lynch, came up with a plan. For a fee, boards could reduce the risk of being overwhelmed by retirement liabilities."

[ChrisNix]

This gives background: https://www.telegraph.co.uk/business/20 ... ays-fund0/

Ah, thanks. This gives some insight. So ultimately Maxwell is at the source of the problem - as with so many things to do with pension funds.

"Eight years after Robert Maxwell plundered the Mirror Group pension pot before his untimely death, the rules changed to force companies to provide greater transparency in relation to their retirement fund obligations. From then on, directors were forced to disclose gaping holes in company retirement funds."

And where there's a problem, there's a solution. For a price.

"Dawid Konotey-Ahulu, then a managing director at Wall Street investment bank Merrill Lynch, came up with a plan. For a fee, boards could reduce the risk of being overwhelmed by retirement liabilities."

In a way leveraged LDIs allowed schemes to lever up so as to have asset exposure greater than 100% of their assets. The regulations only meant they couldn't borrow on balance sheet.

The PR bought that because they saw long gilts a almost riskless for db schemes. Meanwhile schemes could keep much of their equities and property.

No one thought any thing could go wrong. Mind you if rates had risen in the 2010s the market would never have reached its current size!

Chris

[dealtn]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

[Nimrod103]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

Whatever explanation you favour for LDIs, it is clear that they have ultimately relied upon BoE insurance to bail the pension funds out. Did the BoE charge for this insurance? If not, why not?

[dealtn]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

Whatever explanation you favour for LDIs, it is clear that they have ultimately relied upon BoE insurance to bail the pension funds out. Did the BoE charge for this insurance? If not, why not?

I don't think it is clear yet to make a statement about an entire industry. Until we get further detail you, and others, are speculating on the degree of suffering, those that required "bailing out", and what that cost was.

Already you have multiple statements from LDI managers claiming they weren't sellers of Gilts, and many pension managers (in line with their mandates) have expressly said they were buyers of Gilts.

Did the BoE charge debt holders for the rate cutting over the last 20 years or so, and nearly everyone that benefitted from multi-billions of QE to rescue the economy over the last decade? Or are we selective in who we wish to charge for insurance?

[Nimrod103]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

Whatever explanation you favour for LDIs, it is clear that they have ultimately relied upon BoE insurance to bail the pension funds out. Did the BoE charge for this insurance? If not, why not?

I don't think it is clear yet to make a statement about an entire industry. Until we get further detail you, and others, are speculating on the degree of suffering, those that required "bailing out", and what that cost was.

So, if it turns out in say 3 months, that everyone realizes that the pension industry was not, and never had been, at risk,
and that this whole episode had in fact been a deliberate political weapon cooked up from nowhere to crush the Truss/Kwarteng budget,
should we be surprised?

[Dod101]

The bailing out if it was required should have been met by the sponsor companies. The Bankof England, that is the taxpayer, should not really have been involved, except in so far as a disorderly market in gilts is not good for anyone.

And by the way, LDI in itself was not the issue. It was the leverage via derivatives that was introduced by ‘smart’ traders that caused the problem. As gilt interest rates rose after the mini budget, capital values fell, triggering margin calls. With no or not enough liquidity, pension funds had to sell assets, usually gilts, causing them to fall further and creating a truly vicious loop.

That is what Next was worried about but not many sponsoring companies seem to have seen the risks.

Dod

[tjh290633]

My understanding was that, after the Maxwell business, the rules were changed so that pension funds had to invest in gilts with maturities matching their obligations. So you assumed a life expectancy for each pensioner and bought a string of gilts that matured each year in succession covering the amount to be paid out. Ideally you bought gilts at or below par value. The low or negative rates since 2008 have made this unviable, hence the resort to other financial instruments.

Back in the 1970s and 80s I was buying gilts for my mother-in-law with coupons up to 15% and often bought below par. One that I recall was something like 8.5% 1997, bought with a redemption yield of about 13%. They were sold when she went into care and subsequently helped get our children on the property ladder. You could not repeat this exercise in recent years. With the recent start of a return to more sensible levels it may again be possible.

For anyone wanting income, cash savings or gilts have not been a viable option. Equities have been, although with a certain amount of risk. The risk with cash or gilts has been minimal income and a guaranteed capital loss to maturity in most cases. Is it any wonder that ingenious ways to overcome this risk were devised?

TJH

[Alaric]

My understanding was that, after the Maxwell business, the rules were changed so that pension funds had to invest in gilts with maturities matching their obligations.

I think "had" is the wrong word, encouraged or coerced would be a better description. But Maxwell wasn't about equity funding, rather that it was straight forward, albeit undetected, fraud. Bringing pension funds within the scope of the Company audit was a sensible idea assuming the audit was competent enough to uncover fraud. It didn't have to encourage behaviour changes to investment mandates.

[Dod101]

A lot of pension scheme investing has been almost fashion. Like any long term fund, we had them investing in 'safe' assets such as bonds and mortgages for years, and then along came 'the cult of the equity' and they (and ITs) moved largely in to equities and for a while did pretty well. Obviously, the nature of DB pension schemes changed considerably when they were no longer the long term inter generational funds they once were when they started the process of closing them to new members, and LDI has become the 'in' thing. That of course changed the balance of their holdings away from equities to gilts and other bonds. Just as in 2008/9, smart salesmen could not resist offering to embellish them with derivatives to 'improve' the outcome and hey presto we are where we are today.

Dod

[dealtn]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

Whatever explanation you favour for LDIs, it is clear that they have ultimately relied upon BoE insurance to bail the pension funds out. Did the BoE charge for this insurance? If not, why not?

I don't think it is clear yet to make a statement about an entire industry. Until we get further detail you, and others, are speculating on the degree of suffering, those that required "bailing out", and what that cost was.

So, if it turns out in say 3 months, that everyone realizes that the pension industry was not, and never had been, at risk,
and that this whole episode had in fact been a deliberate political weapon cooked up from nowhere to crush the Truss/Kwarteng budget,
should we be surprised?

Yes. That would be a surprise. Merely for the fact that the pension industry has always faced risks, very few (but too many) would make claims that pension funds were riskless.

[ChrisNix]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

[dealtn]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

[GoSeigen]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

Have to agree with dealtn here. My question for him is: as rising rates benefit pension funds is there any mechanism to return value back to the companies whose employees are members of the scheme (i.e. to effectively reverse the extra contributions they were required to make into the funds when rates were falling)?

Would it require a law change?

GS

[ChrisNix]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

Have to agree with dealtn here. My question for him is: at rising rates benefit pension funds is there any mechanism to return value back to the companies whose employees are members of the scheme (i.e. to effectively reverse the extra contributions they were required to make into the funds when rates were falling)?

Would it require a law change?

GS

The return of surplus can be done, but is tortuously difficult.

Everyone knows that when rates rise the value of bonds one would need to hold to cash flow match benefit outflows reduces.

That doesn't mean holding assets which are at severe risk of reducing in value is justified.

Chris.

[Dod101]

And the next mystery is that Bailey should have been on top of this, was definitiely warned about it years ago, and should have stamped the practise out. He didn't, so he should be sacked.

But instead he is feted in Washington, and his pronouncements are currently all over the front page of the Telegraph as if he knows what he is doing.

Bailey has only been Bank Governor for about 20 months, even if it was his responsibility to police the investments of pension funds, which I doubt. How about trying the pensions Regulator?

Dod

[Dod101]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

Different ends of the telescope I think.

Dod