The FT has published a piece this morning suggesting a “blame game” between consultants and the providers of LDI solutions. Was it the providers or the advice given by investment consultants on implementation and management of leveraged LDI strategies that created the reported £500bn lost to the DB sector from exposure to leveraged LDI in 2022?
We know from conversations at the Work and Pensions Committee that there were differences between providers and presumably between consultants. Most schemes did not lose their hedges, but those which did appear to be concentrated where advice was weak and the providers either had high leverage, poor collateral management or both. It would be a mistake to issue blanket blame to consultants or providers since each scheme has its own story to tell. Some schemes have good stories.
For instance, trustees who used Insight, appear to have had a low casualty rate (few clients in Insight LDI pooled funds lost their hedges). Insight’s CEO told the WPC that it ensured its pooled fund customers had a 200 basis point hedge while their rivals worked with much lower buffers. It doesn’t take a rocket scientist to work out that Insight were being responsible here. Yet I haven’t heard any commentary (yet) about the performance of either the providers or the advisers through the crisis.
Many consultants managing LDI inherited the strategies. some schemes appear to have relied almost entirely on a professional trustee, some had in-house teams. We cannot generalise. We need to understand the granularity of the management process to learn for the future.
Things are going to change, and as this blog explains, that change is likely to be expensive and long-lasting.
This argument about how to manage LDI is nothing new – but is it the argument we should be having?
A long time ago, I ran a blog on here about the differing approaches to the management of LDI , adopted by Redington and Cardano. Redington used an approach that Robert Gardner described as “implemented consulting” where the ultimate sign-off on an investment decision rested with the trustee, while Cardano, went a step further and took investment decisions under delegated authorities from trustees. You can read about the public debate that took place back in October 2009 here.
Back then , the question was over the speed of trustee decision making. In those pre-Teams days, assembling a trustee meeting was a difficult enterprise. Leveraged LDI – which by then was making its way down from schemes like Friends Provident to the long-tail of sub £100m arrangements, were generally deemed to need one or other of these approaches.
But the conviction of both protagonists suggested to me then, that the argument was really about how the LDI plans being put in place, could be best managed.
This is the argument that is recurring today. If leveraged LDI can be managed effectively and can add genuine benefit to the schemes in which it is implemented, then what has happened over the last quarter should be the test.
All involved with managing LDI will hopt that if Insight can prove that their approach works, then there is a role for it in the future and consultants and providers and fiduciary managers can continue to argue about who pulls the levers.
So what role for Trustees?
Clearly, one of the reasons for consultants implementing decisions in 2009 is less compelling than today. Trustees can meet quickly online and take decisions in real time.
The issue of trustee competence to take these decisions is also less pressing as more schemes with leveraged LDI have employed professional trustees (named or corporate) who are a halfway house between the lay trustee of yore and the fiduciary manager.
No doubt, consultants with leveraged LDI schemes on their books, will be looking to work more with professional trustees who are capable of sharing both decisions and liabilities for those decisions. The argument for lay trustees (member nominated) is weak, where leveraged LDI is in place
But should technical competence on LDI be essential for pension trustees? In adopting leveraged LDI, consultants made themselves even more essential and trustees less and less in control of how their schemes were funded.
I worry that LDI is the grey squirrel that has rendered most trustee boards redundant. I suspect that this is the conclusion that TPR would like us to draw. The DWP’s funding regulations and TPR’s DB funding code , restrict diversity of thinking by operating a fast-track approach. That approach points to schemes becoming self-sufficient of sponsors and ultimately a part of an insurance company.
The maintenance of leverage LDI is important to this big idea. Trustees may acquiesce to the big idea, but they may see their purpose as different, they may see their conviction as worth following.
The previous point of pension trustees
Traditionally, the trustees of DB pension schemes were there to ensure that pensions are paid to members, part of their work is to limit the strain on the employer to fund this out of money that would otherwise be spent on research on development, wages and on dividends to shareholders.
The LDI saga has set back the aim of many pension trustees to be self-sufficient. Assets have been sold and though schemes are technically more solvent than they were before interest rates go up, when interest rates go down again, the assets will not come back. For schemes that have lost their hedges, their solvency is dependent on interest rates remaining at current levels.
The triangulation between trustees, LDI fund managers and consultants has determined the losses to schemes from the sale of scheme assets and this is the matter that needs regulation.
This of course assumes that LDI was right . is right and will continue to be right. But the high concentration of LDI strategies (over 60% of DB schemes used it) suggests that we still need red squirrels.
It strikes me that there is a lot of difference between the competencies of all three groups and finger pointing by one at another is less important than establishing what works going forward.
Right now , I am not sure that any leveraged model works properly.The nuclear option is to demand that the leverage is taken out of the system. This argument is based on belief among some important figures, including Baroness Sharon Bowles, that it should never have been allowed into the management of occupational schemes in the first place.
But unwinding these hedges looks like a complicated and expensive business meaning that the extension of buffers – as demanded by TPR and executed by the providers, will almost certainly be the interim measure adopted by trustees, under the advice of their consultants and as a condition laid down by the providers.
Once schemes have worked out whether these buffers are in the long-term interest of schemes, then decisions as to whether to continue with LDI can be made.
It is very hard to imagine how the economics of schemes with 300-400bps buffers can be sustainable. But the bumpy ride to a new normal is likely to dominate 2023 and to be an expensive business.
Paying the LDI premium in 2023
The UK Government continues to pay a higher price to borrow money than its counterparts. This appears to be a legacy of the disastrous failure of Trussenomics.
While this high price of borrowing keeps DB schemes looking solvent, it means that when rates do finally fall and the moron premium unwinds, schemes will be left with the same liabilities but less assets – £500 bn less assets.
In the meantime, the big buffers now in place mean that a large proportion of what could be invested for building schemes back , is being tied up in protecting the hedges.
All this change comes at an immense price. Buffers are part of that price. And as Nikesh Patel points out , the cost of maintaining these leveraged LDI positions looks likely to dominate DB strategic thinking in 2023.