Investing for DB pension schemes

[Nimrod103]

BT’s pension fund ‘fell by £11bn’ after mini-budget

The Guardian

Report from one of the UK’s largest schemes is an early indicator of scale of the financial impact on retirement funds

But the value of bonds needed to cash flow match the outflows fell by more, so on bond based measures funding improved.

So this financial catastrophe for DB pension funds was just a con. They are likely to end up better funded. We really have been conned haven't we? It was a manufactured crisis.

[Dod101]

BT’s pension fund ‘fell by £11bn’ after mini-budget

The Guardian

Report from one of the UK’s largest schemes is an early indicator of scale of the financial impact on retirement funds

But the value of bonds needed to cash flow match the outflows fell by more, so on bond based measures funding improved.

So this financial catastrophe for DB pension funds was just a con. They are likely to end up better funded. We really have been conned haven't we? It was a manufactured crisis.

No one has ever said that the assets v liabilities match was the problem. The problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

Dod

[dealtn]

BT’s pension fund ‘fell by £11bn’ after mini-budget

The Guardian

Report from one of the UK’s largest schemes is an early indicator of scale of the financial impact on retirement funds

But the value of bonds needed to cash flow match the outflows fell by more, so on bond based measures funding improved.

So this financial catastrophe for DB pension funds was just a con. They are likely to end up better funded. We really have been conned haven't we? It was a manufactured crisis.

No one has ever said that the assets v liabilities match was the problem. The problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

Dod

See banks 2007/08

[Alaric]

he problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

They created the liquidity problem to avoid the other problem, namely the notional shortfall in assets which arose if interest rates reduced.

[dealtn]

he problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

They created the liquidity problem to avoid the other problem, namely the notional shortfall in assets which arose if interest rates reduced.

Who is "They"?

[Alaric]

They created the liquidity problem to avoid the other problem, namely the notional shortfall in assets which arose if interest rates reduced.

Who is "They"?

Pension funds and their advisers.

It can be doubtful whether the press have the whole story, but those who ought to know, namely the Institute and Faculty of Actuaries are remaining silent.

[Eboli]

Dod said:

No one has ever said that the assets v liabilities match was the problem. The problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

Not sure this is quite right, Dod. It became clear to many Pension Funds 10-15 years ago that the triennial reviews of funding done by the Scheme's Actuary often created large deficits on an ongoing funding basis as well as on a buy-out basis. Indeed this mismatch often became worse when schemes closed (as many did at this time) either to new members or for future accruals of defined benefits. The Liability Driven Investment funds (LDIs) and were instruments invested by the Pension Schemes but offered by large insurers (Legal and General is probably the biggest). They were primarily a mechanism whereby the Scheme's deficits could be reduced substantially on an ongoing funding basis thereby avoiding extra one-off top ups in contributions by the sponsoring employer. It is the insurers who would be subject to the margin calls. I am not aware that L&G had any difficulties and indeed the problem was far more limited that the media has suggested. I understand that only about £4bn of the £65bn allocated by the BoE was actually used. The LDIs are really only put under strain when gilt rates move quickly. Once the volatility falls the risk falls, which appears to be what happened that Tuesday afternoon.

Eb.

[dealtn]

Dod said:

No one has ever said that the assets v liabilities match was the problem. The problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

Not sure this is quite right, Dod. It became clear to many Pension Funds 10-15 years ago that the triennial reviews of funding done by the Scheme's Actuary often created large deficits on an ongoing funding basis as well as on a buy-out basis. Indeed this mismatch often became worse when schemes closed (as many did at this time) either to new members or for future accruals of defined benefits. The Liability Driven Investment funds (LDIs) and were instruments invested by the Pension Schemes but offered by large insurers (Legal and General is probably the biggest). They were primarily a mechanism whereby the Scheme's deficits could be reduced substantially on an ongoing funding basis thereby avoiding extra one-off top ups in contributions by the sponsoring employer. It is the insurers who would be subject to the margin calls. I am not aware that L&G had any difficulties and indeed the problem was far more limited that the media has suggested. I understand that only about £4bn of the £65bn allocated by the BoE was actually used. The LDIs are really only put under strain when gilt rates move quickly. Once the volatility falls the risk falls, which appears to be what happened that Tuesday afternoon.

Eb.

Why should intermediaries face margin calls when they aren't counterparts to a contractual relationship?

Would you be happy paying the increase in value of your house to an estate agent post its purchase (indeed many years after in most cases)?

[Dod101]

Dod said:

No one has ever said that the assets v liabilities match was the problem. The problem was lack of liquidity to meet margin calls. Lack of liquidity can be just as dangerous to the well being of a fund as a shortfall in assets, more so in fact.

Not sure this is quite right, Dod. It became clear to many Pension Funds 10-15 years ago that the triennial reviews of funding done by the Scheme's Actuary often created large deficits on an ongoing funding basis as well as on a buy-out basis. Indeed this mismatch often became worse when schemes closed (as many did at this time) either to new members or for future accruals of defined benefits. The Liability Driven Investment funds (LDIs) and were instruments invested by the Pension Schemes but offered by large insurers (Legal and General is probably the biggest). They were primarily a mechanism whereby the Scheme's deficits could be reduced substantially on an ongoing funding basis thereby avoiding extra one-off top ups in contributions by the sponsoring employer. It is the insurers who would be subject to the margin calls. I am not aware that L&G had any difficulties and indeed the problem was far more limited that the media has suggested. I understand that only about £4bn of the £65bn allocated by the BoE was actually used. The LDIs are really only put under strain when gilt rates move quickly. Once the volatility falls the risk falls, which appears to be what happened that Tuesday afternoon.

Eb.

I am no expert, but why then was it pension schemes that were trying to raise cash and selling their bonds? Legal & General apparently had no problems but then I understood that they were only involved with schemes they had bought out and in an y case they have enormous experience of this sort of thing and are very well capitalised with lots of liquidity.

The other point is that pension schemes can stagger on with substantial deficits for long enough, it is just that nowadays these deficits need to be recognised in the accounts of the sponsor company and they do not like that. Hence 'we have something to solve your problem' and the LDI scheme with leverage built in became popular. LDI in itself does not require leverage.

Dod

[Dod101]

They created the liquidity problem to avoid the other problem, namely the notional shortfall in assets which arose if interest rates reduced.

Who is "They"?

Pension funds and their advisers.

It can be doubtful whether the press have the whole story, but those who ought to know, namely the Institute and Faculty of Actuaries are remaining silent.

Well it is not an actuary's job to worry directly about investments except insofar as it affects the overall financial health of the fund. Their job is primarily to have a stab at valuing the liabilities, so I do not think we should expect them to comment. That is the job of the Trustees, most of whom seem also to have been silent.

Dod

[Steveam]

This article (in the FT today but I’ve found an open link) gives a different and clearer understanding of LDI and the (positive) effect on DB pension schemes … I found it very interesting.

https://moneymarketsquare.com/2022/10/2 ... ve-on-ldi/

Best wishes,

Steve

[ChrisNix]

This article (in the FT today but I’ve found an open link) gives a different and clearer understanding of LDI and the (positive) effect on DB pension schemes … I found it very interesting.

https://moneymarketsquare.com/2022/10/2 ... ve-on-ldi/

Best wishes,

Steve

The LDI force for good stuff is hindsight cobblers.

Had we not had QE and base rate slashing LDI would never have grown to anything like the size it is.

What is true was it gave schemes a large asset exposure to long gilts/bonds, which was a wonderful place to have been from 2011 to 2021.

But less so going forward.

And if rates had risen in past decade I expect many schemes would have decided not to bother.

Chris

[XFool]

I am no expert...

Me neither!

The other point is that pension schemes can stagger on with substantial deficits for long enough, it is just that nowadays these deficits need to be recognised in the accounts of the sponsor company and they do not like that. Hence 'we have something to solve your problem' and the LDI scheme with leverage built in became popular.

LDI in itself does not require leverage.

That is my understanding too. This may well be a significant point of confusion, "LDI" seems to now be a term used to mean a particular LDI implementation package, rather than the original LDI approach itself.

This seems to me an increasing issue in the contemporary world and its reporting. c.f.
If it's green and military, moves and has any kind of gun: It's now "a tank"
"WiFi" used to mean WiFi. Now it increasing seems to mean... "WiFi" ? - or is it "Broadband" ?

Moderator Message:
Attribution corrected. TJH

[XFool]

"The other point is that pension schemes can stagger on with substantial deficits for long enough, it is just that nowadays these deficits need to be recognised in the accounts of the sponsor company and they do not like that. Hence 'we have something to solve your problem' and the LDI scheme with leverage built in became popular."

In the above post these are Dod101's words not mine - mis edited.

[Eboli]

I can only speak as a Pension Trustee of several Schemes.

The LDI investments I am aware of were taken out over a decade ago on two schemes both of which were closed and therefore had liabilities that fell away sharply some 20 or so year in the future (one had a slightly longer tapering curve compared with the other). The LDI investments for both schemes were provided by L&G and were tranched to meet liabilities in five year bundles running 30 years (max) in future. Our main concern was whether the value of these LDIs mirrored the changes to the Actuarial valuation of the liabilities as predicted. That is turn depended upon the normal sort of assumption made including inflation, long-term intern rates and mortality rates (all of which in turn were, so far as it was possible to do so, tailored to the demographics of the particular scheme). None of these involve any contactual dealing with the instruments themselves nor any risks to margin calls. So perhaps there are more racey instruments out there?

Eb

[gpadsa]

This article (in the FT today but I’ve found an open link) gives a different and clearer understanding of LDI and the (positive) effect on DB pension schemes … I found it very interesting.

https://moneymarketsquare.com/2022/10/2 ... ve-on-ldi/

I saw it and read it with interest too

The byline of the FT article: "Abdallah Nauphal The writer is chief executive of Insight Investment"

Being totally ignorant of "Insight Investment" i looked @ wikipedia (the entry has almost certainly been written by their comms dept) https://en.wikipedia.org/wiki/Insight_Investment
"Insight Investment (Insight) is one of the largest global asset management companies [...] manages strategies which include fixed income, liability-driven investment (LDI), [etc, ...] is a subsidiary of The Bank of New York Mellon".

So the Insight man has skin in the game. Maybe the FT article is an edited version of the kind of pitch he makes to DB pension scheme trustees

Which would make it even more interesting

gpadsa

[Dod101]

This article (in the FT today but I’ve found an open link) gives a different and clearer understanding of LDI and the (positive) effect on DB pension schemes … I found it very interesting.

https://moneymarketsquare.com/2022/10/2 ... ve-on-ldi/

I saw it and read it with interest too

The byline of the FT article: "Abdallah Nauphal The writer is chief executive of Insight Investment"

Being totally ignorant of "Insight Investment" i looked @ wikipedia (the entry has almost certainly been written by their comms dept) https://en.wikipedia.org/wiki/Insight_Investment
"Insight Investment (Insight) is one of the largest global asset management companies [...] manages strategies which include fixed income, liability-driven investment (LDI), [etc, ...] is a subsidiary of The Bank of New York Mellon".

So the Insight man has skin in the game. Maybe the FT article is an edited version of the kind of pitch he makes to DB pension scheme trustees

Which would make it even more interesting

gpadsa

Yes but the only mention that I could see of the need for liquidity is to cover the 'collateral requirement of hedges'. That does not tell me a lot.
Insight is selling their wares in the article and I do not criticise them for that but to me the article does not really get me much further in my understanding of the problem.

Dod

[Steveam]

Dod101 wrote “… does not really get me much further in my understanding of the problem.“

The author discusses (mid article) that the pension funds hold a liquidity buffer and if this gets depleted too quickly may lead to selling other, liquid, assets and thus the downward spiral. The author explains the issue and why the BoE had to step in.

Best wishes, Steve

[ChrisNix]

I can only speak as a Pension Trustee of several Schemes.

The LDI investments I am aware of were taken out over a decade ago on two schemes both of which were closed and therefore had liabilities that fell away sharply some 20 or so year in the future (one had a slightly longer tapering curve compared with the other). The LDI investments for both schemes were provided by L&G and were tranched to meet liabilities in five year bundles running 30 years (max) in future. Our main concern was whether the value of these LDIs mirrored the changes to the Actuarial valuation of the liabilities as predicted. That is turn depended upon the normal sort of assumption made including inflation, long-term intern rates and mortality rates (all of which in turn were, so far as it was possible to do so, tailored to the demographics of the particular scheme). None of these involve any contactual dealing with the instruments themselves nor any risks to margin calls. So perhaps there are more racey instruments out there?

Eb

Eb,

So how did your LDIs differ from just buying AA bonds and matching the outflows?

Or where there more in the nature of interest rate swaps?

Chris

[dealtn]

Eb,

So how did your LDIs differ from just buying AA bonds and matching the outflows?

The first, and most obvious difference, was they didn't require any cash up front to execute as a (hedge) investment.