When the Bank of England stepped in to the long dated gilts market in September last year, it did so to stop contagion from the collapse of certain pooled LDI funds.

It is now becoming clear that at least two of the pooled funds, had to change the valuation  of the assets they held, to avoid the price of the funds from going negative – effectively meaning their funds were bust.

Jessica Tasman-Jones of FT ignites europe covered this in a “fund director briefing” that was discretely published in a mailing entitled  Directors grapple with pricing questions in wake of LDI crisis

Liability-driven investment fund managers have been criticised over their handling of asset valuation during the fallout from the UK government’s disastrous mini-Budget.

The Bank of England has said that the net asset values of a number of LDI funds had been at risk of going negative before its intervention on September 28.

Experts say fund boards may have moved away from so-called mark-to-market pricing around this date to avoid highlighting that their funds slipped temporarily into negative territory.

No asset managers have admitted doing so.

Without forbearance from the counterparty, a negative NAV would result in a fund going bust, compounding the forced selling of gilts into an already stressed market.

Some counterparty arrangements mean a fund must maintain a minimum NAV and could therefore go into default before hitting negative territory.

Fund boards at both Insight Investment and Legal & General Investment Management adopted fair value adjustments at the time.

While fair value adjustments are accepted practice, they are typically applied to rarely traded securities, not gilts where there is market pricing.

“It was self-serving, making them look better compared to their rivals,” says one portfolio manager. “I have never come across using fair value [adjustments] to price up a portfolio.”

Con Keating, chair of the bond commission at European Federation of Financial Analysts Societies, says the correct course of action for a fund with a negative NAV would have been to value the fund based on market pricing and to ask forbearance for some period.

“If they grant it, there is no immediate need to start the insolvency/liquidation process,” he says.

Simeon Willis, chief investment officer of XPS Investments, a pension consultant, adds that it would not make sense to follow through with a closure of a fund if its NAV went negative and was back in positive territory the following day.

However, he adds: “We were happy with the approach that was taken using price adjustments in response to a very unusual situation.”

A spokesperson from LGIM says fair value pricing is a “recognised mechanism used by asset managers in certain market conditions, such as, where there is a clear market dysfunction”.

“Fair value pricing decisions taken by LGIM are subject to well established governance oversight and approval and are taken in the best interest of clients and their investment outcomes,” the spokesperson says.

A spokesperson from Insight says: “The majority independent fund board considered a range of options before deciding that making a fair value adjustment was in the best interests of shareholders. The decision was taken after the Bank of England announced its intervention in the gilt market, indicating that the market was dysfunctional. This is a well-established valuation mechanism, which is described in the fund prospectus.”

Valuation of assets under stressed scenarios is likely to be one focus within the Central Bank of Ireland’s discussion paper on macroprudential rules for investment funds due next month, says Adrian Whelan, global head of market intelligence at Brown Brothers Harriman. The paper has partly been driven by the LDI crisis.

However, the European Securities and Markets Authority’s publication of its final report on a common supervisory action on fund valuations released in late May generally found good practice, he says.

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Wise after the event?

There must have been some very relieved fund directors when the Bank of England intervened. I am surprised that more is not being made , not just at how close some pooled funds were to going bust, but with the risks taken by fund directors with other people’s money. It would seem that at least one consultancy was aware that unit prices were effectively being “made up” by insurers and ran with it.

If there had been no intervention and gilt prices had continued to fall, who would have been responsible for meeting the “fair value prices”, established by the Funds and not the market? When Andrew Bailey said that he had but an hour to save the financial system, what would have happened if he’d delayed? Would those “fair prices” have been exposed as an artifice? Would two managers LDI funds have gone bust?

Did “fair value valuations” happen after the BOE intervention (as Insight are suggesting), if so why couldn’t the manager hang on till the impact of the announcement normalised gilt prices? And why was this not mentioned when Insight gave evidence to the WPC on what happened to pooled LDI funds in September?

This may be a story that the managers of LDI pooled funds don’t want to discuss.  Because there was a happy ending and the crisis was averted by the intervention , we may consider this a “non-story”.

But it seems to me that the LDI fund managers were knowingly taking a risk not just with their policyholder’s money, but with the credibility of the gilts market.

Fair value pricing may have saved the day, but how did that day arise and what would have happened if the BOE had left the market to sort itself out?