Last week was one of the most turbulent ever for those managing UK pension schemes. In this article, one fiduciary manager talks about his experience of the past seven days.
What actually happened?
Gilt yields rose sharply following the mini-Budget with the sheer movement by Wednesday mid-morning being unprecedented for the UK pensions industry. To put it into context, the global financial crisis seemed like a walk in the park in comparison.
Pension schemes hedge interest rate risk - the effects of movements in UK gilt yields - and, in theory, should have been protected from what happened. However, hedging is often achieved through leverage or gearing - where only a portion of assets is used to hedge a much larger liability value. This structure has been in place for many, many years and has served UK pension schemes well to date.
However, the scale and speed of movement in gilt yields this week created an enormous stress on the system, which was at risk of getting seriously out of control until the Bank of England intervened. As gilt yields rise, pension schemes need to post collateral, and when they rise so much, that fast, pension schemes with collateral calls had to be ready to sell everything they could get their hands on as fast as they could in order to post collateral. Tens of billions of equities and credit had already been sold before the Bank of England stepped in, and perhaps an order of magnitude more was on the line.
This was not an investment crisis as such but more of an operational crisis centred on collateral management. It was a huge test for pension schemes and asset managers and, unfortunately, many suffered with hedge positions being lost. With gilt yields falling sharply after the Bank of England intervention, those pension schemes that lost their hedge positions will have suffered financially, some potentially significantly. Incredibly, due to being locked-out of the system, some schemes didn't even know when they lost exposure during the day and to what degree hedges were reduced. That's a concern in itself.
What was the experience on the front line?
For the most part, the nature and speed of events caught out the entire pensions industry - asset managers, banks, pension consultants, trustees and sponsors.
The first time many trustees and sponsors heard about the chaos, it was already so far gone that the options available were focussed on fire-fighting - including some sponsors effectively directly writing cheques to cover collateral shortfalls. And to those of us in it, it seemed no one outside of the pension industry seemed to notice for the first two days of the crisis. All the attention was on sterling at that point.
I heard stories of trustees signing documents in the middle of the night, investment consultants working all night writing instruction letters, checking trades by eye, working on day-old data (or worse) and liability-driven investment (LDI) pooled funds actually stopping their clients' exposures and ceasing to trade altogether - and many that threatened to do so.
At Kempen, you could tell everyone knew and felt the seriousness of the situation, with the sheer level of focus creating a strange calmness amongst all the market turmoil. We had a plan for crises, implemented that plan and streamlined the processes to deliver it. Stress levels were clearly high - through the roof probably - but ironically it helped all our different teams pull together in achieving the one key aim - raising enough cash in a controlled manner to maintain our clients' hedge positions - which we succeeded in doing. Perhaps being a fiduciary manager and being set up to manage risk and implement efficiently helped us, to help our clients. It's fair to say that everyone was exhausted after such a challenging few days.
What position is the average pension scheme with LDI in now following the volatility experienced?
Impossible to say - there will no doubt be a divergence between schemes that maintained hedging and those that did not, and for those that did, a divergence in how much selling they had to do (if any).
Almost every pension scheme in the UK had to sell assets to realise cash for potential collateral calls and crystallise losses from longer term equity market falls this year - though at least those assets weren't also in crisis at the same time.
In the coming months, pension schemes will be more cash heavy, and with a more liquid profile. This is likely a good thing, as volatility is still high, and there remains the possibility of the crisis reigniting. Some further selling of liquid growth assets is likely as pension scheme looks to rebalance asset allocation, and an element of illiquid growth assets will need to be sold too in order to avoid overconcentration in these assets.
From here on, we expect downward pressure due to the Bank of England's action for the next two weeks, which will increase if the Bank needs to raise rates to prop up sterling at some point, if the politics does not catch up with the economics.
If there is no extension to the Bank of England's latest quantitative easing action, or further policy announcement from the Government to undo the fiscal initiative, yields may then rise again. All eyes are fixed on the next OBR forecast, and 23 November when the Chancellor will deliver the next Budget.
Are they in a broadly similar position vis-à-vis funding, have things improved or has funding fallen?
As mentioned earlier, those schemes that lost their hedge positions this week will have lost out financially due to losing exposure at a higher gilt yield and missing out on the ‘hedge' when gilt yields fell on Wednesday.
Iain Brown is head of UK strategic fiduciary management clients at Kempen
