Just had a very interesting webinar on the implications for pension schemes of the almost unprecedented rise in gilt yields in the last week in September.
Pension trustees and fund managers are very busy reviewing their investments and many if not most are, or will be, making significant changes to their holdings as a result.
The rapid sell down wasn't just sentiment, it was fuelled in part by the immediate necessity for pension schemes to sell gilts in order to meet their obligations.
Many schemes use leveraged liability driven investment (LDI) to enable them to hedge interest rate and inflation effects while making reasonable returns. As a result of the turmoil, they have faced much larger collateral calls than they might reasonably have foreseen and, whilst they hold liquid assets for this purpose, in some cases these have run out and the hedging has had to be reduced. In other cases less immediately liquid assets (investments) are now being sold down to provide liquid collateral in case of future calls.
Ironically the effect on investment will be negative. As everyone knows, pension schemes are big investors and funds held by schemes commonly invest in long term illiquid assets. The desire for these illiquid investments is now reduced.
Kwarteng has in effect scored a hat trick of own goals. The view from the City is that the market turmoil was exacerbated by the failure to use the OBR and the sacking of the permanent secretary to the Treasury on day one.
The effects are not over. LDI leverage is likely to settle lower, as are hedging ratios unless schemes accept lower returns which would create bigger deficits.
I would think the effect on perceptions of Kwarteng's and Truss's competence (the belief is she told him to do it) will be long lasting.
www.reuters.com/markets/europe/what-is-ldi-liability-driven-investment-strategy-explained-2022-10-04/
The Bank BTW hasn't actually spent £65bn buying gilts. They have reportedly bought about £5bn worth. Their pledge of £65bn to support gilt prices has so far been enough to reassure potential sellers and/or deter short sellers. But BoE might have to renew its support pledge after 14 October.
What a mess.
Last edited by: Manatee on Thu 6 Oct 22 at 14:47
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