“More that unites than divides” – Ralfe and Keating as one on LDI.


The market volatility that is causing the problems for LDI


It’s helpful to think about local issues, like the current LDI crisis in terms of investment philosophy. In this article, I argue that two protagonists, who see pension fund investment differently are drawn together by an aversion to LDI.

Although John Ralfe and Con Keating have diametrically opposed views on the fundamentals of valuing and funding  DB pensions , they find themselves saying the same things about the LDI crisis.

Agreement that those behind pension funds should be held to account

Writing in the FT, Ralfe argues that an investigation is needed to hold those behind [the] UK pension crisis to account”.

Ralfe does not point the finger but concludes

Given the scale, and speed, of the leveraged LDI turmoil, the BoE, the Treasury and the Pensions Regulator should have an urgent investigation to pool information and hold those responsible for this mess to account.

Agreement that leverage or borrowing is the heart of the matter

The issue for Ralfe is not that pension schemes are invested in gilts, but that they are over-exposed through borrowing.

We are left in a position in which the taxpayer has effectively had to bail out pension schemes via the Bank of England intervention. This is moral hazard writ large: “Heads we win, tails we come asking for a taxpayer bailout . . . ”

Con Keating’s assessment of the causes of the problem aligns with Ralfe’s. At the First Actuarial Client Conference we both attended, Keating warned that pension schemes should not expect the Bank of England to support pension schemes deleveraging beyond October 14th. Like Ralfe, he sees LDI as borrowing and like Ralfe he sees it being used as an investment strategy as plain wrong.

Agreement on risks LDI post to the wider financial system

Both Ralfe and Keating accept that there  are wider issues than those that impact our parish.  Ralfe is clear about this in his FT article.

By increasing leverage, many UK pension schemes have been operating as badly run hedge funds, increasing risk for themselves and the whole financial system. This greed, stupidity and laziness was encouraged by investment consultants, who get paid for complexity.

There are many articles on the “complexity premium” and I am sure that Keating and Ralfe would happily set a match to all of them. The complexity in pensions introduced by LDI has blindsided many trustees and Keating and Ralfe are as one as seeing this as creating risk for the whole financial system.

Agreement on the need for change.

We are currently seeing an attempt by consultants , fiduciary managers and the Pensions Regulator to convince us that the retreat from highly leveraged bond positions is orderly.

One wrote to me yesterday with this advice

“Going forward DB schemes are going to need to know exactly what their liquidity waterfall looks like, have a plan for how they will fund further capital calls if they are required (noting these could be required very quickly if the gilt market volatility continues) and review their allocation to illiquid assets – Particularly whether they remain appropriate going forwards”

This is in line with the  Regulator’s response to the questions posed by the parliamentary Work & Pensions Select Committee and their new guidance “Managing investment and liquidity risk in the current economic climate”.

Pension schemes may well be asking whether they should have been told this prior to thanksgiving day.

Keating like Ralfe has been warning schemes of the risks ahead for the 1000 days of the turkey’s life that preceded the day it was “surprised” by the “one in a thousand chance” event of a sharp rise in gilt yields.

But here the paths trodden by Keating and Ralfe begin to divide

I need to add a caveat, agreement on LDI , does not mean Keating and Ralfe will lay down their cudgels.

John Ralfe continues in his FT article to condemn not just the borrowing but the “speculation” that the borrowing delivers.

What we see now is happening because pension schemes have been speculating — investing in equities, private equity and hedge funds, with disguised borrowings or leverage — not hedging.

The austere philosophy behind financial economics prohibits reliance on the growth in real assets which it deems “speculation”. This is why, under Ralfe’s direction, Boots’ pension scheme was at one time 100% invested in fixed interest securities where the only risk being taken was of default on the debt and the increase in liabilities, debt instruments cannot match – chiefly longevity. Boots’ pure LDI involved neither leverage or “speculation” but it was quickly discarded as impractical.

Keating’s view of the pension fund management is quite different – seeing pension funds as impactful in the real economy driving productivity up through investment in real assets.

The fundamental driver of Ralfe’s puritanism is a belief that assets should be valued on a mark to market basis, as prescribed in regulation since the Pensions Act 2004. Keating points to the Pensions Act 2004 and its accounting standard as a principle driver for pension schemes gearing up bonds. Keating’s counterfactual is a single valuation method he and his colleague Iain Clacher call the Contractual Accrual Rate (CAR) a measure of return agreed by the scheme at outset as determining whether the scheme is in deficit or surplus. Unlike a mark to market approach, the CAR smooth’s out the volatility of market fluctuations.

For Ralfe, LDI is both illegal ( it involves borrowing and pension funds cannot borrow) and its purpose is to enable speculation. For Keating LDI is both illegal and unnecessary, pension schemes do not need the level of bond exposure mark to market valuations require, because the CAR includes the returns expected from “speculative” assets.

More that unites than divides

Keating and Ralfe are very different people with different investment philosophies, but they are as one in their view of LDI. They are the dissenting voices that challenge received ideas. It is difficult for either to agree that they are in agreement but it’s clear that on LDI they are.

Since they are variously thought of – in differing circles – as authoritative, that their views are congruent on LDI is worth our attention.

I will finish with John Ralfe’s call for action, one that I agree with and one that I expect will resonate with many readers – including Con Keating

Since leverage is the cause of the whole problem, pension funds should be banned from using leverage, however cleverly disguised.

I’ll give the last word to an anonymous poster on Citywire’s New Model Adviser site. It is not just economists who should be asking these questions.



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 “More that unites than divides” – Ralfe and Keating as one on LDI.

  1. con keating says:

    The investigation should really be conducted by Work & Pension Committee and Treasury Select Committee – the Pensions Regulator has far too much to answer for – and their evasions and mis-directions now should not be allowed to succeed.

  2. pjlee01 says:

    Institute and Faculty of Actuaries, experts in risk management currently boasting of your skills in managing climate change risk: where are you on this?? Why the continuing silence?

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