LDI – “Blood on the Tracks”

Well, I wanna be your lover, babyI don’t wanna be your bossDon’t say I never warned youWhen your train gets lost

Bob Dylan “It takes a lot to laugh, it takes a train to cry

This article is about the troubles created for pension funds by what is being called a “gilts crisis”. Writing in the FT this morning , Chris Giles did not beat around the bush.

Following the Bank of England’s statement that it would be buying long-dated bonds to stabilise a situation  that posed a “material risk to UK financial stability“. Chris Giles commented.

The BoE added the action … came after market participants said there was a “proper shit show” happening.

Defined benefit pensions are at material risk

Thousands of pension funds have faced urgent demands for additional cash from investment managers in recent days to meet margin calls, after the collapse in UK government bond prices blew a hole in strategies to protect them against inflation and interest-rate risks.

“Don’t say I never warned you”

For several years , Con Keating and Iain Clacher have been using this blog to warn us of the consequences of over-reliance on gilts to fund UK pensions. The system of borrowing using derivatives so that a pension scheme benefits from the upside of gilts by borrowing to “double up” is known as LDI or “Liability Driven Investment”. Last Friday it exploded.

I use the Bob Dylan lyric because it expresses the regret those who care about the state of pensions have for their charges. Keating and Clacher have been lone voices, the “boss” – the Pension Regulator is finding the train getting lost while these prophets , whose voice has been ignored, now are left not laughing, but mourning the damage needlessly done to our defined benefit pension system.

The train got lost

LDI started out well enough, a couple of bankers at Merrill Lynch in the noughties, using new financial tools to match liabilities to investments. It spread quickly and became mainstream thinking so that within two decades almost all pension schemes were borrowing using derivatives to cover their exposure to inflation and rising gilt yields. And so long as gilt yields remained low, the derivative programmes did what they said on the packet , providing predictable income streams and the promise of money back at the end of the gilt’s term. Till this year the train was on track

Except the train was not in the control of its passengers and it’s course in 2022 veered wildly away from the chosen destination, the train got lost, it take a train to cry.


The train crash

The 3 decade long Gilt bubble is well and truly over . Quantative Easing has stopped and must turn into Quantative tightening, with the consequence that long term interest rates will revert to their centuries long average, basically 5%. – Stanley Kirk

You might argue that Trussmoronics has done no more than accelerate the train into the buffers. But the train crash has happened. This is how the Times reported it yesterday

City chiefs have expressed concern that an unprecedented rise in yields on long-dated government bonds is inflicting huge and sudden cash calls on traditional pension funds that could damage the gilts market.

Investors dumped 30-year gilts yesterday, sending their price sharply lower and their yield soaring 45 basis points to 4.97 per cent, a huge rise for a single day.

Other gilt yields also rose yesterday, with ten-year bonds rising by 26 basis points to 4.5 per cent and five-year bonds rising 15 points to 4.67 per cent.

Pension funds are suddenly being hit with repeated calls for cash as collateral from fund managers running so-called liability driven investment (LDI) funds on their behalf. The fund managers are in turn being hit by cash calls from investment banks that act as counterparties on the other side of the bet.

Legal & General, one of the biggest players in LDI, issued some of its clients with an emergency call for cash on Sunday night, to be received by yesterday.

If Clacher and Keating were writing as “lovers” what of the “boss“. We are told by the Times.

The Pensions Regulator expressed concern, saying trustees and advisers should look at the resilience of their investments, risk management and funding arrangements.

Not that that would have been much help, if BlackRock gone ahead with their strategy of unhedgeing their more vulnerable clients without giving them the option to stump up cash

The FT reported

BlackRock is “not proceeding with any further recapitalization events until further notice”, in an  email to LDI clients, which was seen by the Financial Times and was sent at about 11am, before the Bank of England announced its emergency intervention to stabilise the gilt market.

It takes a lot to laugh

The money from the cash-calls isn’t lost, it is transferred to a collateral account and  spent if there is a need to buy back the asset (repo is short for repurchase order). So if gilts become more valuable again, the money in these collateral accounts becomes available to buy other assets (more gilts or perhaps more productive assets ). For strong schemes, there could yet be a happy ending.

But not all schemes are strong. Many can’t sell other assets because those assets are illiquid (typically invested in private markets ). Some pension funds are being forced to sell gilts, which forces down prices and pushes up yields. That in turn runs the risk of triggering fresh collateral calls and a fresh round of selling.

Pension funds are being given only one or two days’ notice to find the cash, rather than the several weeks’ grace given them in more normal times. That can turn them into forced sellers.

Meanwhile the fund managers who package the LDI portfolios have started issuing risk warnings – presumably at the insistence of their lawyers.

This appeared on Insight’s weekly newsletter for the first time this week

The scale of these leveraged losses is staggering. Here are some numbers provided me by Con Keating

The gilt market mayhem continues today – the twenty year conventional opened this morning at 4.35% down from 4.59 as yesterday’s close – it has been one way traffic, it is now trading at 4.82% 





That is the widest day’s trading range in my 50 years. The 1/8th% 2068 ILG was trading last Thursday evening close at 99.55% it has just traded at 57.2% – down 43% as near as makes no difference.

Think of a twenty year discount function (1/(1+disc rate)^20) – at 4.35%,

 4.35        0.426727795

4.59        0.407564867

4.82        0.390046956 

That is a price range of 8.5% in the course of a day.

You can’t buy a thrill

As we now know, the meltdown was averted because the Bank of England threw the switch on a £65bn gilt buy-back reversing its propose quantitative tightening.

15 year bond yields continue to rise , though not at the same rate

As subsequent blogs point out, the problem’s deferred not solved. If you are a trustee , you can’t buy a thrill, jeopardy is waiting , there could be Blood on the Tracks.

An immediate correction but yields rising again – blood still on the tracks

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to LDI – “Blood on the Tracks”

  1. John Mather says:

    Post hoc is a particularly tempting error because correlation sometimes appears to suggest causality.

  2. con keating says:

    Neither Iain nor I take any pleasure in these developments. We certainly did not foresee the turmoil which has come about. We warn our children to take care when crossing the road, but we have the same horror as others when they have accidents.
    There are two webinars available which cover our views. One on Pension Playpen, Here:

    and one on the Z-Ten Long Finance website. Here:

  3. Eugen N says:

    Buying derivatives without understanding them = Stupidity investing!

    Hard to add something else. You can have LDI investing by buying gilts and strips to match liabilities with no leverage. These investments are sold by investment bankers to trustees with little investment knowledge.

  4. Jnamdoc says:

    Have long been a strong advocate of Keating & Clacher. But we need to focus more on the why has this occured? This is 100% down to the interventionist attitude of TPR forcing schemes to hold gilts, but also sythetic gilts. I fully expect TPR to do its usual and tell scheme review appropriateness of its arrangements blah blah blah, pass the buck.
    The real question is will TPR break the BoE, or will BoE at long last sort out the reckless prudence foisted upon schemes (and our economy) by an unregulated TPR.

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