Is LDI fundamentally unsuitable to small DB schemes?


Evan Guppy runs a multi-billion pound leveraged LDI program for the Pension Protection Fund. The collateral calls it met over the September/October crisis involved posting £1.5bn in cash and gilts

For the first time before during or after the LDI crisis, a leading practitioner has said , what commentators on this blog have been saying, that LDI has impacted small schemes to a much greater deal than the pensions industry (including its regulator) has admitted.

Thanks to Maria Espidanha of the FT for her excellent reporting.

Speaking at a Pension Playpen event on November 29, Evan Guppy noted that there is a “tail of schemes that weren’t able to put capital in to maintain their interest rate and inflation exposure exactly […] when they should be looking to increase their hedges”, and the true impact will not be known “until we start getting the annual accounts for these schemes in the next 18 months or so”.

The asymmetry of DB pension fund is well known. Even though the PPF 7800 is now down to 5200 DB schemes, the majority of the assets are in a minority of big schemes, not big enough for some!

To which John Ralfe has posted this question

John should have been on the Pension PlayPen call – it would have provided one answer to that question.

If size matter – why are there so many small DB schemes?

Well as trustee to a few , John will know that small schemes keep idle hands employed and gainfully employed. The DB master trusts make play with the cost savings that can be achieved by pooling investment, administration and advice and this is undoubtedly the case.

The case against smaller DB schemes consolidating into master trusts  going to buy out or transferring to a superfund is not made on the “money” leg of the VFM stool but on the “value” that small schemes bring in maintaining control of their strategies.

This argument is blown out of the water if the price of control is the total loss of control of an investment strategy when a strategy goes wrong.

Commenting on evidence given in the second session of last week’s evidence to the WPC , Roman Kosarenko points to the dangers of implementing ideas out of context

One of the many interesting questions at yesterday’s session was from Con Keating (get well soon) who asked why the Bank of England needed to intervene in the LDI crisis well before the pre-stress-tested trigger for calamity had arrived. As Keating pointed out, the damage was being done at around 37bps , suggesting that the actual tolerance to rises in the long term rate of Government borrowing was well below what TPR had tested for (100 bps).

Herein may lie the hidden tale which Guppy refers to. I suspect that the arrangements that small schemes entered into through the pooled funds offered them, were not so efficient as TPR imagined when doing its testing.

This is a challenge for the Work and Pensions Committee to take up. If we really have to wait till small schemes publish their account (and I said as much to the WPC last week) , then we risk those schemes that survived the first and second routs (Guppy was clear that there were cash calls in June/July as well as Sept/October), may not survive a third. Indeed Guppy explicitly stated that this.

Which suggests that there is serious residual risk in LDI pooled funds.

Until the detail of what has happened to the hedges maintained for small DB schemes in pooled funds becomes clear. Pressure will mount on both TPR and FCA to intervene in the management of those funds to ensure that a third wave does not precipitate more trouble.

The PPF is not regulated by the Pensions Regulator but the Pensions Regulator has a job to do protecting the PPF from the failure of small schemes. So necessarily the two have a symbiotic relationship. In saying what he did yesterday, Guppy is giving both the market and the regulators a clear heads up on where there may still be problems.

The FT and this blog amplify that message. To use  Macbeth’s macabre analogy

“we have scotch’d the snake not killed it”

Macbeth’s remedy for the damage he has done in killing Duncan is to kill again.

Better be with the dead,
Whom we, to gain our peace, have sent to peace,
Than on the torture of the mind to lie
In restless ecstasy

I suspect that many Jacobean audiences would have empathised with Macbeth who finds himself in a mess rather harder to get out of , than get into.

The regulators may, at least for smaller schemes, need kill off LDI, before LDI kills more. But we are left wondering  – how did it come to this?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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3 Responses to Is LDI fundamentally unsuitable to small DB schemes?

  1. John Mather says:

    It is very clear that the extent of the loss to the balance sheets of DB is no more than a damp finger in the air. Why can this not be quantified?

    Given the absence of facts how can a solution be offered?

    Then again the industry has for many years contented itself in shutting stable doors as a substitute for forward thinking. The PPF seem to be adopting proactive strategies that work.

  2. Martin T says:

    Rather than kill off LDI (which would mean a loss of face) I suspect TPR will use this situation as an excuse to try to kill off smaller schemes – a policy they’ve been pursuing for years in practice if not officially.

  3. John Mather says:

    In the 80’s endowment policies were defined as toxic by looking only at one side of the equation, Advisers were blamed and compensation was paid. Who will be responsible for compensation with LDI? Are small schemes the new “retail client”?

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