There is no such thing as “risk free” – even when lending to our Government.

In the financial crisis the financial system nearly brought down the Government because of their financial imprudence. Now it’s the other way around, the Government’s imprudence is threatening the financial stability of the UK – including the banks.

But this is happening because our great pension funds are far too exposed to so called “risk-free” returns from Government debt. The long term returns may be stable, but that does not immunise pensions, they have become a crisis accelerator because they are the pinch point where all the risk from a spike in government borrowing costs is concentrated.

This blog simply explains why pension schemes are in the mess they are in – and points the finger not just at the Government, but in pension scheme groupthink that thought that governments manage risk well.

The breakdown of good Government over the past two months is a very British thing.

There is one graph that I have been looking for , since the latest Government line came out – the one about the gilts crisis being part of a global crisis.

While it is true that the cost of government long term borrowing has increased in other countries, the scale of the increase in the UK dwarfs our competitors. The rise in the hike in UK rates is down to local rather than global factors.

When the cost to pension schemes is measure by each basis point (0.01%), a rise in rates of 186 bps can be catastrophic, especially where pension schemes have been relying on Government and the Bank of England to manage borrowing costs within a narrow band.

The deal between Government , BOE and pension schemes is longstanding. Pension schemes sacrifice yield in return for the security of the risk-free rate, the low but unspectacular gilt rate.

That is why pension schemes feel so aggrieved and it’s why pension schemes felt entitled to BOE support next week. But pension schemes, like the general public, have been let down by the irresponsible behaviour of the Government which has led to enormous damage to our pension funds and will lead to further cash-calls on employers as a result.

It is also fair to say that pension funds have been irresponsible in their behavior though they have been led on by the Government’s own Pension Regulator and by the groupthink of advisers and fund managers who did too little stress testing and relied on phrases such as “risk-free” too much and too long.

The grim irony is that we have given away all the growth stored in pension fund strategies to investment banks who now hold the proceeds of the fire sale of equities as cash on their balance sheets. In short, they are now in a position to hold the shares our pension schemes sold them at knock-down prices, and they can buy now gilts at a fraction of the price that pension schemes bought them in the years of slim yields.

This awful situation is the result of bad political decisions that result from a breakdown of good government. Liz Truss was voted to power by a small number of members of the Conservative party – no more than 80,000. She didn’t win the hearts and minds of the majority of her (properly elected) parliamentary party who favored a different policy – Rishi Sunak’s.

What happened to pension schemes (and will continue to happen as the Bank takes away its support at the end of today) is clearly the fault of Liz Truss and Kwasi Kwarteng. But we have to accept that bad politicians do make it to the top – and that is the risk that makes gilts less than risk-free. It is only if we believe in perfect Government that we can use phrases like “risk-free”.

Commentators are now talking about Britain  having to live with higher borrowing costs than other developed countries because lending to us carries a “risk premium” – like lending to someone who has had a history of CCJs. This may or may not happen but by the time we find out – the damage to pension funds will have been done.

Relying on the risk-free rate of gilts is like relying on good Government. Most of the time we get it, but when we don’t!

We must never find our pension funds so dependent on gilts again.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to There is no such thing as “risk free” – even when lending to our Government.

  1. John Mather says:

    I sent the performance graph to you yesterday of the 3/4 RPI linked Treasury 2034 which I bought yesterday at less than the issue price in March 2011 in Sterling terms, apart from default, how do you fall off the floor?

    The challenge with financial planning is to turn adversity to advantage and to anticipate adverse consequences of past actions or current mania.

    however the rules and the herd look at recent events and with hindsight create a rule which links the two events. This works until it doesn’t. Cycles are more commonly much longer than human memory. Current problems are rooted in demographics from the 1969’s and the impact on productivity plus Remuneration of industry leaders who know they have a short lived opportunity to get rich so created share buy backs. Brexit and other self inflicted damage accelerate the correction.

    DB models ignore many threats and only really work for those funded by taxation for as long as the public tolerate the game

    A new world might define the objective of providing at least an index linked living wage and a dynamic model to monitor progress on an individual basis

  2. Jnamdoc says:

    It’s too easy, too simplistic to blame it on current PM or ministers, and it misses the fundamental point. If they (Govt) are at fault it’s for not ensuring sufficient oversight over a DB pension system that ‘somehow’ got itself into an LDI basket of at least £1.6trn (and using the £trn shorthand minimalizes the issue) on the simplification that that gilts are risk free. You can’t build a system that only functions so long as interest rates remain are historically low. Under LDI, any rise in rates leads to a transition out of growth assets, and a transfer of cash to the banks. That was the model, recent events have by accident shone a light on it.

    All involved in pension schemes agree with you and are heartsick of having to sell off cherished growth assets, handing over eye wateringly huge bags of cash to the banks on LDI losses – and yet not a jot of hubris or backtrack or apology from the Regulator; rather more of the same, and schemes to provide PoAs to LDI managers to confiscate assets. You really couldn’t make up this level of single-minded short-sightedness.

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