For reasons I won’t go into, I had a Teams call at 4.30 yesterday with Fiona Bruce who was “excited” to be talking about pensions.
I have to say I was excited to be talking with Fiona Bruce.
Fiona Bruce wanted to know why “pensions” had prompted the Bank of England to reverse quantitative tightening and buy £5bn of gilts. The answer is of course that many pension schemes are suffering a cash flow crisis as they struggle to enough money in their collateral accounts to stave off having to sell their prized gilts at knock-down pricing – or as the technicians put it “losing their hedge”.
This is not a balance sheet crisis, pensions are currently running very healthy balance sheets as their valuations are showing them generally solvent. This is a cash flow issue for reasons I went into yesterday, the cause of which is explored by Con Keating and Iain Clacher in their article on scheme funding , coincidentally published this morning. As they conclude.
It seems to us that the concept of an asset allocation that is “highly resilient to short-term adverse changes in market conditions” is a chimera.
The financial economists are keen to deride anything that cannot be measured “mark to market” as “magic beans”. They are now finding that the hidden risks of LDI are not only capable of bringing down a pension strategy, they can bring down an economic strategy, perhaps even a Government.
I hope that Fiona Bruce got that message.
We seeded Japanese Knotweed (not magic beans)
It may be, due to the unprecedented experiment of quantitative easing, something that resulted from the last bout of reckless financial irresponsibility, that LDI served a lot of pension schemes well – as an investment. The relentless fall in yields led to gilts becoming highly prized, fuelled by the relentless demand for gilts as the Regulator urged schemes to buy more and to sell the productive capital in their portfolios.
But at some point, the suppression of yield had to stop and it stopped when the combined impact of QE, C19 measures and finally the “Growth Plan 2022”, spooked the market. The price of some gilts are down more than 40% since Thursday, even after the BOE intervention.
To suppose, as Fiona Bruce had clearly been told , following her briefing in Downing Street, that matters were and are under control is a statement of heroic self-confidence. It suggests that because Downing Street wills it, it will be so. But history tells us that that kind of hubris is just petrol to the flames, the market is looking for contrition not hubris and it is clearly not getting it.
There are magic beans in our pension schemes, Repos and Swaps which are normally dormant but which, once germinated, act like the Japanese knotweed that swiftly takes over the garden.
You want engagement – you’ve got it!
The pension industry from the PLSA down craves attention, it doesn’t get attention for paying pensions, it gets attention when it gets itself in a mess (Maxwell, Equitable, ASW, BSPS). Like background music, it works best when it isn’t being listened to.
But in a crisis, it cannot turn to the public and say that it has no crisis, that assumes we know what is happening to schemes being called on to find cash where there is no cash. These schemes have to liquid assets from growth portfolios that have been increasingly investing in illiquids (as called upon to do by this Government). Where they run out of liquid growth assets (because they have “de-risked” into gilts) , schemes have to start selling gilts, and selling at the current discount prices. This is where things become seriously “unstable”.
We cannot pretend we are not in a crisis
I am close enough to a few DB schemes to know that all of those that have seriously committed to LDI are close to the red line. The red line is the point where they have to sell the gilts (the equivalent of the family silver) to satisfy the demands of the counterparties to the derivatives they have purchased.
Most will get through , usually with the support of the sponsor and of the sponsor’s banks. Lines of Credit are being arranged as I write, it is probably the banks that are telling the Bank of England of the crisis.
The week after next I will be on stage at the opening discussion of the PLSA discussing the topical issues of the day. There will be well over a 1000 delegates and I expect many of them to be very frightened, not just professionally , but personally. This crisis feeds into the cost of living crisis, the impact on interest rates will mean that many people in the audience (and on stage) will be worrying about whether they can pay the mortgage, stay in their pension and meet the rising cost of household bills. And if they aren’t worrying for themselves, they certainly should be worrying for those who they serve – their members.
Faced with this fear, the pensions industry can pretend that it is groundless and resume talking about engagement, increasing pension contributions, ESG. Or it can start asking itself some more fundamental questions , like what it is there for.
We are here to pay pensions, and if not pensions, at least organise wealth in such a way as people can meet their retirement needs. Large parts of the pensions industry is dependent on gilts and there is no doubt that we are in a gilt-crisis. How the industry reacts to that crisis and manages its way through it will be its major test. The collapse of financial institutions in 2008 shows that no pension scheme is too big to fail.
“Failure” in this context, means the failure to meet the collateral call, the loss of the hedge and the enormous cost of losing the long-term value of the scheme’s assets. We simply don’t know what failure looks like but the Bank of England is certainly worried – citing pensions as the reason for the buy back of £5bn of gilts.
Failure is also in the automatic transfer of DC savings into corporate bonds and gilts that members are told are “low-risk”. For many savers into workplace pensions from their late fifties onwards, the gilt-crisis means a dramatic fall in the value of their retirement wealth.
The eyes of the nation are on us and it is for us to show we are worthy of the pride we attach to what we do.
Excellent. We must not forget the “WHY” – this is solely down to TPR dogma coercing Trustees to hold synthetic gilts. The latest blog from Con Keating and Ian Clacher on this provide excellent technical critique. The question now is will TPR accept its failings and culpability (I doubt – on past record they will double down, and blame Trustees for not anticipating thi), will it come under leash from BoE, or will TPR yet break BoE and lead to a run on the £.
No one had to hold synthetic gilts. The trustees are culpable for buying stuff they did not understand from investment banks. They have an informational edge on the trustees and their investment advisor if they retained a proper fee based one.
They had to hold assets matching liabilities, corporate bonds, strips and Gilts. These are bought and held. There was no need to create any synthetic bonds or Gilts, buying risk spreads etc.