Despite a sharp increase in U.K. borrowing costs, pension funds have not only survived but thrived in the recent volatility. This resilience is attributed to several factors, including a more measured yield increase compared to the 2022 'mini-budget' crisis, higher funding ratios, lower leverage, and improved governance models.
A sharp surge in U.K. borrowing costs this year has triggered memories of the 2022 'mini-budget' crisis, which shook the country's pension funds. However, this year, U.K. pension providers have not only weathered recent volatility in government bonds, but they have also benefited from it, even increasing their so-called liability-driven investments (LDIs) that previously caused such havoc. Earlier this month, gilt yields spiked to their highest levels since 2008 before cooling nearly as fast.
Still, they remain elevated. On Wednesday, gilt yields ticked lower after U.K. Finance Minister Rachel Reeves promised to go 'further and faster' to boost Britain's sluggish economy. Yields across the board were 3 basis points lower at 11:50 a.m. London time.In September 2022, a massive sell-off in U.K. debt drove down the value of assets held by pension funds, triggering margin calls on their LDI funds. These largely leveraged investments are often used by pension funds as a hedge against factors such as inflation and interest rate movements. The ripple effect from the margin calls threatened to push several defined benefit pension funds into insolvency. The 'mini-budget,' announced by then-Prime Minister Liz Truss, was unveiled at a time when U.K. inflation was soaring, interest rates were rising, and the economy was stagnant. Market turbulence prompted the Bank of England to intervene with an emergency bond-buying program to stabilize the market. Investors still experience a slight degree of 'post-Truss stress disorder' when bond prices fluctuate, said Jason Borbora-Sheen, portfolio manager in the multi-asset team at investment manager Ninety One. Industry participants stressed that U.K. bond market moves this year have not come close to the mini-budget in terms of volatility, and that pension funds have more than kept their cool, for several key reasons.One factor helping pension funds remain calm relates to the broader macroeconomic environment, particularly the fact that yields were moving higher in sync with a global trend as investors factored in a slower pace of interest rate cuts this year. Gilts have moved sharply on specific data releases in 2023 such as inflation, wage growth data both at home and in the U.S. They've also responded to investor reactions to the U.K.'s fiscal outlook and the impact of recent monetary policy decisions. 'The market didn't run away with itself,' said Simon Bentley, head of U.K. solutions client portfolio management at Columbia Threadneedle. 'There weren't a whole load of technical things going on in the market that really created a bit of a spiral and caused yields to just go exponential. On this occasion, it was very clear what was driving it, and it was macro and monetary policy.' 'We called capital into a couple of portfolios, as I know other managers will have done, but it was very much initiate a standard process, standard time frame,' Bentley added. At the Universities Superannuation Scheme (USS) — Britain's biggest private pension scheme — market watchers have been taking a similarly calm stance on elevated gilt yields. The USS manages assets worth £77.9 billion ($96.7 billion), with its subsidiary USS Investment Management Limited deciding where to invest funds. 'It's all very much business as usual for us here,' a spokesperson for the USS said in emailed comments. They noted that Truss' mini-budget had acted as a catalyst for a rapid, large-scale shift in markets, whereas the current elevation in prices has taken place over a longer period. Other key differences that have helped avoid disruption in British private sector defined benefit (DB) funds — workplace pensions that promise to give holders a certain annual payout after retirement — has been higher funding ratios, lower leverage, and improved governance models since 2022. 'Post the LDI crisis, pension schemes now have higher collateral buffers capable of withstanding at least a 3% increase in real yields compared to 1% in 2022,' a spokesperson for Brightwell, the U.K.'s biggest corporate DB scheme, said by email. 'The yield increase has been more measured than during the LDI crisis. As a result, pension funds are well prepared and managing the volatility effectively.' Ninety One's Borbora-Sheen noted that the U.K.'s Pensions Regulator had recommended those higher buffer limits post-2022, which meant that a 'doom loop' would no longer occur if yields rise quickly. Meanwhile, he added, allocations within pension funds to gilts have gone down, and the Bank of England has shown its willingness to intervene in the market, providing a sense of comfort.Beyond withstanding the recent market moves, higher yields have actually been a 'nice little opportunity for pension schemes,' said Columbia Threadneedle's Simon Bentley. 'Yields going up and gilt prices going down, is actually very positive for pension scheme funding levels,' reducing the value of a DB pension scheme's liabilities, he said
PENSION FUNDS U.K. ECONOMY BOND MARKET GILTS LIABILITY-DRIVEN INVESTMENTS (Ldis) INTEREST RATES INFLATION FINANCIAL MARKETS
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