The crisis that rocked the UK’s pension funds last week could soon be repeated overseas as rising interest rates squeeze so-called liability driven investment (LDI) globally, analysts have warned.
UK funds deploying LDI strategies came under extreme strain in the fallout of the Chancellor’s tax-cutting mini-budget as gilt yields soared and prices tumbled. Volatility forced funds to stump up cash for hefty collateral calls and sparked a scramble to sell off assets on the cheap to meet the calls.
Analysts at UBS said today that while the UK was at heightened risk of a meltdown, “the core issues are present in leveraged positions held by a variety of investors across markets.”
“This means risks are present broadly, and in the wake of the UK event we think investors will end up holding more cash to protect against margin calls,” analysts said.
They warned that fund managers would be forced to boost their liquidity to meet potential collateral calls, which could choke off potential returns in the longer run.
“Essentially the deterioration in liquidity (specifically market depth) in rates markets means investors need to hold more liquidity, which will dampen long term performance,” they said.
The LDI strategies at the heart of the crisis have been rolled out globally in the past two decades as corporate sponsors looked to steady wild swings in their pension liabilities driven by inflation and interest rates. The strategy uses debt to invest in a mix of assets that will offset the volatility in liabilities.
Around £1.5tn is held in funds deploying LDI strategies in the UK which fuelled fears that savers’ cash was in jeopardy last week at the heat of the crisis.
Analysts at MSCI said rising interest rates rise globally could soon put pension funds in other markets under similar pressures.
“This past week’s events in the UK bond market serves as a cautionary note to investors: What happened in the UK could also happen elsewhere,” said MSCI’s head of portfolio management research Andy Sparks.
Fund managers have already been tweaking and rowing back on the leverage used in the strategies this week after the mini-budget sent shockwaves through the City.
The world’s biggest asset manager, US firm BlackRock, said last week it was slashing leverage in its LDI funds and boosting liquidity. “We have been reducing leverage in some of our LDI funds, acting prudently to preserve our clients’ capital in extraordinary market conditions,” a spokesperson said last week.
L&G – one of the UK’s largest pension firms – moved to reassure investors of liquidity position this week amid concerns it would be caught up in the crisis.