Stories from the front line: The LDI crisis

Professional trustee Graham Jung, investment consultant Paula Champion, and Charles Stanley’s Senior Portfolio Manager Bob Campion all give their views on what has happened since the crisis – and what it will mean for trustees’ future plans.

The trustee view: Graham Jung, Professional Trustee at Pi Pension Trustees

What happened?

“A lot of schemes effectively went through trauma late last year. Even in early 2023, quite a large proportion of trustee boards were still unsure about the position of their scheme, in terms of the shape and scale of their hedging, the value of their private assets and other measures. It took until the second quarter of this year for schemes and trustees to really start to get to grips with their hedging and funding levels – and then decide where to go from there.

“I was involved in many conversations about re-examining the current position of schemes, deciding where trustees and sponsors want the scheme to get to, how quickly that can be achieved and the staging points involved.

What's next?

“Once that picture has been redefined and decided, then trustees can think about the practicalities of achieving their goals. That includes fiduciary management needs, as well as deciding how to use strategies such as LDI.

“We expected to see a lot of turnover in managers, but there has been slower decision-making and more planning involved. Schemes are asking what their ultimate end game is and how to get there, and then thinking about how to implement that plan.”

The consultant view: Paula Champion, Head of Fiduciary Management Oversight at ISIO

What happened?

“There has been a lot of soul-searching from trustees around governance and the challenges they faced during the LDI crisis, such as the speed of finding funds, getting signatures, decision-making, level of investment expertise on trustee boards and risk management.

Some schemes have seen their funding levels improve, but others have not been so fortunate. The key thing to acknowledge is that funding levels have shifted and the portfolio needs to change in response.

Isio found that, looking across their FM clients, 65% was the largest single reduction in hedge ratio in the crisis, which represents a big increase in risk exposure. Some reductions in hedge ratios were uncontrolled, some schemes lost exposure where risks were not properly understood or there was challenge in managing the calls effectively. Others may have reduced them due to liquidity concerns."

What's next?

There was sympathy in the moment for fund managers and others in a highly pressured situation, but since then trustees have expected clarity over what happened. That includes any losses, transparency over the approach that fiduciary managers and fund managers took, the risks they now face – and how they move on. That includes protection against risks for the future, including those we haven’t yet been exposed to.

If a fund is now under hedged, or over hedged, being aware of the reasons why is really important. It is imperative to understand why you have a particular approach to hedging, and to think about the unintended consequences.

The fiduciary manager view – Bob Campion, Senior Portfolio Manager at Charles Stanley

What happened?

In September and October last year, we had to raise cash for our clients to meet an intense burst of collateral calls from LDI managers. Charles Stanley could meet those calls for our fiduciary management clients because we have high levels of liquid assets in our portfolios. But not all schemes could do that, especially those without fiduciary managers or with illiquid assets that couldn’t be sold quickly enough to raise the cash needed.

Since then market movements have been less intense, but the current environment has by no means returned to stability. We have seen more collateral calls in the last few months, and with interest rates at the highest they have been for decades, there may be more to come. It’s unclear where the future direction of gilts lies.

What's next?

We are now living in a different world. Schemes will need to think about different strategies, measures of risk and asset allocation within their portfolio. For example, the equity risk premium – the measure of the value of earnings per share, minus the rate of interest you would get on a government bond (perceived as a low-risk asset) - is now around 1%. In 2011, it was 6%.

Trustees should also take heed of involvement from regulators and others around LDI. We’ve already had guidance from The Pensions Regulator, and a parliamentary committee investigation into whether pension funds should be invested in leveraged LDI strategies. The FCA has also issued guidance for asset managers offering LDI funds. This will mean long-term changes for trustees’ governance and their management of providers.

We are seeing increased pressure on fund managers too. Not all performed in the same way during the crisis, or provided the same level of service to investors. We expect to see much more scrutiny of LDI managers in the future.