Schemes urged to review cash investment policies in wake of LDI crisis

HSBC Asset Management said the government's Mini Budget on 23 September last year and the resulting Sterling market volatility had thrown a spotlight on how cash is managed within liability-driven investment (LDI) programs.

It said that, in particular, a steep increase in the Sterling yield curve during the crisis had impacted the mark-to-market valuations of longer-dated money market securities - adding that margin calls within LDI programs had initially led to large cash-calls and significant redemptions from a number of LDI-affiliated money market funds (MMFs).

HSBC AM said the pressure on mark-to-market net asset values (NAVs) of MMFs had led to valuations slipping, in some cases, to the "lower end" of the 20 basis point regulatory collar for low-volatility MMFs in Europe, the rules under which the majority of the Sterling MMF industry is governed.

It said had any of these NAVs moved outside the collar they would have been moved to become so-called "variable NAV funds" - meaning they would float and fully reflect market valuations.

HSBC Asset Management global chief investment officer (CIO) for liquidity and UK CIO Jonathan Curry said the crisis had highlighted a number of issues in relation to Sterling-denominated money market funds.

And he said, while the impact the Mini Budget crisis had on Sterling markets and the knock on impact of that to LDI strategies was well-known, the issue of client concentration risk in MMFs with pension fund assets was possibly less well known.

Curry said: "For many years, we've been talking about the importance of MMFs managing client concentrations, because it can have a significant impact on the management of liquidity risk.

"For funds that offer clients same day liquidity, managing that liquidity risk is critical. And it is not just about managing the liquidity of the assets but also managing the same day liability that the funds have to the clients who want to redeem from those vehicles. You have to manage both."

Curry added: "If you have either individual client concentrations or if you have client concentrations from certain client types, then that is a risk."

Checklist for trustees

HSBC AM set out a "checklist" of areas schemes and their trustees could consider in a bid to ensure cash investment policies and processes were as robust as possible going forward.

First of all, it said diversification was paramount - noting it had always been critical to diversify cash but the market events of last year served as a "timely reminder" to ensure this is applied universally and robustly.

HSBC AM said schemes should also consider using more than one MMF - noting that, for LDI programs, the default or incumbent cash option could have a high level of concentration from other pension schemes which can put pressure on the fund if there are large outflows at the same time.

It said expanding the number of MMFs used, including those with less concentration risk from LDI or other captive cash, supports diversification.

The asset management firm said schemes should also review the process for how cash is invested - explaining that subscriptions to and redemptions from MMFs are easily instructed, even if outside of a default LDI option, and adding that, in many cases, custodians have solutions to sweep cash from custody accounts to and from different MMFs.

It said schemes could also consider non-Sterling MMFs to reduce exposure to Sterling volatility and potential illiquidity.

Trustees could also use the review process to look at sustainably invested options for cash - assessing credible ESG-specific MMFs or mandates to support a broader approach to sustainable investing.

Finally, it said schemes could consider other investment options, such as tailored investment mandates which could precisely match the investment restrictions and requirements of the pension fund, including ESG investment criteria.