Investing for DB pension schemes

[XFool]

I have now found an available link to this FT article, as mentioned by Dod101 yesterday, that is in proper English:

UK pension fund crisis shows there is no capitalism without capital or risk

https://jnews.uk/uk-pension-fund-crisis-shows-there-is-no-capitalism-without-capital-or-risk/

As I 'translated' the mangled English version I found yesterday it will be interesting to now compare my translation to the original.

[XFool]

"We now need to put in place a new, longer-term and more resilient savings system, better matched to the long-term interests and global competitiveness of the real economy. We need a pension system that is more inclusive of all generations and especially one that can supply long-term risk capital to support the economic growth ambitions to which our new government is committed."

Um... Puts me in mind of some (unpopular) ideas I floated a few years ago on TMF wrt pensions. Instead of all these closed individual company DB pensions (not to mention individual pensions), why not pool them into a much larger stand-alone fund and run it as an ongoing, non time limited, pension fund. Rather like those original DB pension funds, before they were closed to new entrants.

[scotview]

I suppose the million dollar question now for DB pensioners is, have DB pension schemes become less likely to fail catastrophically as of today compared to Friday.

Are there still extremely rocky times ahead, or will the severe risk of failure just apply now to, say, schemes underfunded by 50% with sponsors having weak balance sheets ?

[Alaric]

I suppose the million dollar question now for DB pensioners is, have DB pension schemes become less likely to fail catastrophically as of today compared to Friday.

Are there still extremely rocky times ahead, or will the severe risk of failure just apply now to, say, schemes underfunded by 50% with sponsors having weak balance sheets ?

If by DB pensioners you mean those past retirement age actually receieving benefits, they are higher in the priority chain than those who have yet to reach retirement age. The Pension Protection fund is the bailout of last resort which would be triggered if the pension fund would bring down the sponsoring company. The shareholders of the sponsor take the hit first.

[NotSure]

I suppose the million dollar question now for DB pensioners is, have DB pension schemes become less likely to fail catastrophically as of today compared to Friday.

Are there still extremely rocky times ahead, or will the severe risk of failure just apply now to, say, schemes underfunded by 50% with sponsors having weak balance sheets ?

According to PWC, DB schemes are in very good shape. Rising yields caused a very temporary liquidity issue that could have snowballed without BoE intervention, but are otherwise a good thing.

https://www.pwc.co.uk/press-room/press-releases/uk-pension-schemes-still-reach-record-collective-funding-level.html

I cannot find the article now, but I also read that the BoE have only used a very small fraction of the allocated £65B in the 'pension support' scheme. Something like £22M of the £5B available today, for example.

[BullDog]

I suppose the million dollar question now for DB pensioners is, have DB pension schemes become less likely to fail catastrophically as of today compared to Friday.

Are there still extremely rocky times ahead, or will the severe risk of failure just apply now to, say, schemes underfunded by 50% with sponsors having weak balance sheets ?

According to PWC, DB schemes are in very good shape. Rising yields caused a very temporary liquidity issue that could have snowballed without BoE intervention, but are otherwise a good thing.

https://www.pwc.co.uk/press-room/press-releases/uk-pension-schemes-still-reach-record-collective-funding-level.html

I cannot find the article now, but I also read that the BoE have only used a very small fraction of the allocated £65B in the 'pension support' scheme. Something like £22M of the £5B available today, for example.

A little reassuring too that at least for now, LGEN shares are stabilised.

[GoSeigen]

The folk narrative appearing in this thread (and also repeated in the FT article) of gilt yields being driven down by pension fund buying is bogus. Buying an asset does not in itself drive the price anywhere. One might as well say that the enormous issuance of gilts over the same period has driven down yields. Such a statement is self-evidently nonsense and the one about pension funds, attractive as it is to a neophyte, makes as little sense.

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

It is far more interesting and productive to discuss WHY purchasers were happy with such low yields than whether the mere fact of their buying (or the sellers' selling) caused yields to drop.

GS

[NotSure]

The folk narrative appearing in this thread (and also repeated in the FT article) of gilt yields being driven down by pension fund buying is bogus. Buying an asset does not in itself drive the price anywhere. One might as well say that the enormous issuance of gilts over the same period has driven down yields. Such a statement is self-evidently nonsense and the one about pension funds, attractive as it is to a neophyte, makes as little sense.

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

It is far more interesting and productive to discuss WHY purchasers were happy with such low yields than whether the mere fact of their buying (or the sellers' selling) caused yields to drop.

GS

I thought the narrative was that bond yields were driven down by massive intervention by BoE, and that they were briefly driven up by mass selling by pension funds to cover margin calls on their derivatives?

Anyway, as you say, yields have dropped and stabilised, and the BoE has actually bought few. Maybe just the fact the BoE 'sprang' into action was enough to satisfy buyer and sellers at the higher price? Sometimes just pulling out a gun is enough - no need to actually fire it?

paywalled article: https://www.telegraph.co.uk/business/2022/10/03/bank-england-signals-wont-keep-borrowing-costs-rejects-19bn/

The Bank of England has sent a clear signal that it will not hold down UK government borrowing costs after Threadneedle Street rejected almost £1.9bn in bond offers at a special auction.

Last week, officials launched a £65bn emergency bond buying programme designed to halt a run on pension funds and restore financial stability. It has been holding daily auctions offering to buy up to £5bn in a bid to smooth market functioning and quell “dysfunction”.

However, the Bank spent just £22.1m on gilts – or government bonds – on Monday. This is well below its threshold and compares with £1.89bn in bonds investors offered up but rejected.

Market watchers took the outcome as a sign that the Bank does not want to be seen to be funding the government by keeping borrowing costs low, a charge known as “fiscal dominance”. Buying at any price offered by the market could drive up the value of bonds and push down yields........

[GoSeigen]

For far too long in the industry (and on this site) we have had people saying Bonds are safe, far less volatile than equities, immune to large market moves etc. Maybe the reality of the last couple of weeks will begin to dilute that view.

Who said this and what is wrong with those statements? They are all true if understood in the right context;

1. "Bonds are safe". Yes they are senior to hybrid securities and equity and subject to statutory protections. 100% fair to say they are safe compared to shares.
1. "far less volatile than equities". Yes, a short duration bond is far less volatile than long duration equities most of the time.
2. "immune to large market moves". Who says this without qualification? This is essentially the same thing as 1 and 2 in different words. Short duration bonds have small market moves except in default situations -- and tell us all, what is the outlook for equity in a default scenario?

So what exactly is the quibble here, and with whom?

GS

[XFool]

Just when you thought...

The folk narrative appearing in this thread (and also repeated in the FT article) of gilt yields being driven down by pension fund buying is bogus. Buying an asset does not in itself drive the price anywhere. One might as well say that the enormous issuance of gilts over the same period has driven down yields. Such a statement is self-evidently nonsense and the one about pension funds, attractive as it is to a neophyte, makes as little sense.

Well, some of the "neophytes" are, we are given to understand, insiders and people who 'know', allegedly. (Also, the explanation wrt recent events included pension funds selling Gilts etc.)

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

Is not this no more than the correct, full description of what people mean when they casually say financial products are being "sold down" etc? i.e. it is just a simple shorthand for what is happening? (Somebody usually pops up to point out that "if people are selling somebody else must be buying" etc.)

Then there is this, from above:

UK pension schemes reach record collective funding level- PwC UK

https://www.pwc.co.uk/press-room/press-releases/uk-pension-schemes-still-reach-record-collective-funding-level.html

"The UK’s 5,000-plus corporate defined benefit (DB) pension schemes are now estimated to have sufficient assets to ‘buy out’ their pension promises with insurance companies, according to a new analysis from PwC. Last week’s unprecedented levels of interest rate volatility presented operational challenges for pension schemes that employ ‘liability-driven investment’ (LDI) strategies. However, when looking at the full picture of both assets and liabilities, the funding status for most pension schemes is at a strong level."

Sufficient assets for a "buy out"! That is surely well above normally required continuing DB pension schemes 'funding levels'. So, if true, what is the problem?

On the face of it the above appears to fly in the face of the understanding arrived at in the thread above. Or is it possible to reconcile this PWC report with the previous understanding of LDI?

Years ago, on TMF, I once said something like: "I have concluded everything I read about pensions is wrong"

Perhaps time to resurrect that idea?

[GoSeigen]

The folk narrative appearing in this thread (and also repeated in the FT article) of gilt yields being driven down by pension fund buying is bogus. Buying an asset does not in itself drive the price anywhere. One might as well say that the enormous issuance of gilts over the same period has driven down yields. Such a statement is self-evidently nonsense and the one about pension funds, attractive as it is to a neophyte, makes as little sense.

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

It is far more interesting and productive to discuss WHY purchasers were happy with such low yields than whether the mere fact of their buying (or the sellers' selling) caused yields to drop.

GS

I thought the narrative was that bond yields were driven down by massive intervention by BoE, and that they were briefly driven up by mass selling by pension funds to cover margin calls on their derivatives?

Indeed. Which is nonsense as I explained.

Anyway, as you say, yields have dropped and stabilised, and the BoE has actually bought few. Maybe just the fact the BoE 'sprang' into action was enough to satisfy buyer and sellers at the higher price? Sometimes just pulling out a gun is enough - no need to actually fire it?

Being a forced seller is humiliating. It is not the fact of selling (in whatever volume) that means the price is low, rather that you are required to sell whatever the price. Completely different things IMO. I don't see that yields have done much. They are back to where they were a few days ago, in other words at more than ten-year highs.

paywalled article: https://www.telegraph.co.uk/business/2022/10/03/bank-england-signals-wont-keep-borrowing-costs-rejects-19bn/

The Bank of England has sent a clear signal that it will not hold down UK government borrowing costs after Threadneedle Street rejected almost £1.9bn in bond offers at a special auction.

Last week, officials launched a £65bn emergency bond buying programme designed to halt a run on pension funds and restore financial stability. It has been holding daily auctions offering to buy up to £5bn in a bid to smooth market functioning and quell “dysfunction”.

However, the Bank spent just £22.1m on gilts – or government bonds – on Monday. This is well below its threshold and compares with £1.89bn in bonds investors offered up but rejected.

Market watchers took the outcome as a sign that the Bank does not want to be seen to be funding the government by keeping borrowing costs low, a charge known as “fiscal dominance”. Buying at any price offered by the market could drive up the value of bonds and push down yields........

IMO the primary reasons for yields being where they are are:
1. They were too low before, and
2. The market is reassessing its view on future inflation levels. Inflation is destructive for bonds because their cashflows are fixed.

The stuff about pension funds and government mistakes is just noise and post-hoc justification.

GS

[GoSeigen]

Is not this no more than the correct, full description of what people mean when they casually say financial products are being "sold down" etc? i.e. it is just a simple shorthand for what is happening? (Somebody usually pops up to point out that "if people are selling somebody else must be buying" etc.)

There are quite possibly people who know better but use "sold-down" as a lazy shorthand, in which case shame on them! There are far more people who appear to use this concept as their primary and "clever" means of understanding market action. They deserve the investment losses they are almost certain to encounter as a result. But we don't have to perpetuate the fallacy in our discussions here.

Years ago, on TMF, I once said something like: "I have concluded everything I read about pensions is wrong"

Perhaps time to resurrect that idea?

I might be wrong but as I said in my previous post I think this pension business is a sideshow, along with the stuff about Credit Suisse and KK. It's typical market-washout talk. I'd be very surprised if there isn't a strong rally around the corner.


GS

[XFool]

IMO the primary reasons for yields being where they are are:
1. They were too low before, and
2. The market is reassessing its view on future inflation levels. Inflation is destructive for bonds because their cashflows are fixed.

The stuff about pension funds and government mistakes is just noise and post-hoc justification.

This doesn't make any sense to this neophyte.

We know inflation has risen (we've noticed), we know rising inflation deflated bond prices (we are not that naive), the point about pension funds is surely a consequence of these facts - given DB pensions, LDI, derivatives, margin calls etc - rather than a cause. Who here was saying otherwise?

Plus issues arising from the recent budget.

[GoSeigen]

IMO the primary reasons for yields being where they are are:
1. They were too low before, and
2. The market is reassessing its view on future inflation levels. Inflation is destructive for bonds because their cashflows are fixed.

The stuff about pension funds and government mistakes is just noise and post-hoc justification.

This doesn't make any sense to this neophyte.

We know inflation has risen (we've noticed), we know rising inflation deflated bond prices (we are not that naive), the point about pension funds is surely a consequence of these facts - given DB pensions, LDI, derivatives, margin calls etc - rather than a cause. Who here was saying otherwise?

Plus issues arising from the recent budget.

You raised the issue of recent gilt price falls, not me. I was talking about dealtn's comments on this thread and the common narrative about pension fund purchases driving down gilt yields. I thought I made that pretty clear in my first post to the thread? Of course similar could be said about "selling driving up yields" but that was not what was on my mind...

GS

[Dod101]

I cannot enter into the argument about what causes what but to me there two things to note.

I think I have made the first point before (not sure on this thread or not; there are a number of threads on the same general subject).

The first is that confidence that all is well is evidently a necessary ingredient in the DB pension system and when that is lost, we get the mass concern/panic which can and does cause real problems as we have seen. That is not just a DB pension confidence; it is confidence in the entire financial system.

The second thing is specific to Bulldog and anyone who has a DB scheme which has been bought out by Legal & General. This morning's RNS by them gives some background to how these work and he and others should surely read it for interest.

Dod

[Alaric]

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

Why was this though? Could it have had something to do with closed defined benefit pension schemes being required to purchase indexed securities as a matching asset for their indexed liabilities. It's not a closed market because there were continuous new issues as the government tried to finance its deficits. For as long as inflation remained low, there would be an arbitrage against non-indexed bonds, so their prices went up as well and the yields down. Doesn't QE also make it something of a false market since it's just one branch of government trading with another branch?

[tjh290633]

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

Why was this though? Could it have had something to do with closed defined benefit pension schemes being required to purchase indexed securities as a matching asset for their indexed liabilities. It's not a closed market because there were continuous new issues as the government tried to finance its deficits. For as long as inflation remained low, there would be an arbitrage against non-indexed bonds, so their prices went up as well and the yields down. Doesn't QE also make it something of a false market since it's just one branch of government trading with another branch?

Wasn't the principle that the fund bought Gilts, I-L or otherwise, with maturities to match their future liabilities? I'm looking here at pensions in payment, not those of active members. Buying and holding to maturity is fine for new issues, but could be disastrous if the gilt to be bought was at a hefty premium.

TJH

[Alaric]

[
Wasn't the principle that the fund bought Gilts, I-L or otherwise, with maturities to match their future liabilities? I'm looking here at pensions in payment, not those of active members. Buying and holding to maturity is fine for new issues, but could be disastrous if the gilt to be bought was at a hefty premium.

That was the principle, but there are some practical points. Inceasingly schemes didn't have any active members either because they had all left the Company or because the scheme had left them by closing both to new membership and additional accrual. When that happens you also have bond like liabilities for people with benefits frozen except for indexation, but who won't be taking an income for another ten, twenty years or longer. There aren't howrver indexed zero coupon bonds, even if recent low coupon issues come close, so the available assets are of a shorter term than the liability cash flows. Hence presumably LDis which attempt to allieviate the losses that would otherwise arise when interest rates fall and a reason why a rise in interest rates is good in a slightly longer horizon for a closed scheme.

There's a theorem on valuation of future cash flows which is always worth bearing in mind. It's this, that if you take two sets of cash flows and value them using the same rate of interest, you find that the set of cash flows that on average is further in the future will change values more when interest rates change.

[dealtn]

For far too long in the industry (and on this site) we have had people saying Bonds are safe, far less volatile than equities, immune to large market moves etc. Maybe the reality of the last couple of weeks will begin to dilute that view.

Who said this and what is wrong with those statements? They are all true if understood in the right context;

1. "Bonds are safe". Yes they are senior to hybrid securities and equity and subject to statutory protections. 100% fair to say they are safe compared to shares.
1. "far less volatile than equities". Yes, a short duration bond is far less volatile than long duration equities most of the time.
2. "immune to large market moves". Who says this without qualification? This is essentially the same thing as 1 and 2 in different words. Short duration bonds have small market moves except in default situations -- and tell us all, what is the outlook for equity in a default scenario?

So what exactly is the quibble here, and with whom?

GS

So your context is to specifically use the niche set of "short" bonds, an asset class rarely invested in or by definition held by Pension Funds when the discussion is based around the "forced" risk matching of long term liabilities with "appropriate" assets?

If you need the concession that short duration bonds are less volatile, or risky, than shares (or long duration bonds) I am very happy to oblige. Perhaps you can now reciprocate by focussing your response to those bonds as assets actually used by such funds in their hedging and duration matching

[ChrisNix]

The folk narrative appearing in this thread (and also repeated in the FT article) of gilt yields being driven down by pension fund buying is bogus. Buying an asset does not in itself drive the price anywhere. One might as well say that the enormous issuance of gilts over the same period has driven down yields. Such a statement is self-evidently nonsense and the one about pension funds, attractive as it is to a neophyte, makes as little sense.

Gilt yields have fallen for the simple reason that buyers increasingly were comfortable with a lower yield and sellers (both the issuer and secondary market participants) naturally were happy to sell at increasingly low yield.

It is far more interesting and productive to discuss WHY purchasers were happy with such low yields than whether the mere fact of their buying (or the sellers' selling) caused yields to drop.

GS

If banks are lent funds by BofE at increasingly low interest rates, they and their hedge fund clients can be expected to gorge on the carry available in bonds, in particular gilts.

The pension funds are rather caught by the Pension Regulator's mantra that gilts are always perfectly priced and all investment decisions must be made off back of that.

Chris