Pension trustees urged to act 'now' before BofE interventions end

Industry experts have emphasised the need to learn from the issues that arose amid market volatility over the past week, with pension scheme trustees also urged to take "urgent" action before the Bank of England’s (BofE) short-term fix expires.

The BofE announced plans for temporary and targeted purchases in the gilt market earlier this week, in an effort to "restore orderly market conditions" following an unprecedented surge in gilt yields.

However, the Bank emphasised that these are temporary measures and "strictly time limited", as they are intended to tackle a specific problem in the long-dated government bond market, with auctions to take place until 14 October.

Speaking to Pensions Age, Mercer partner and investment consultant, James Brundrett, urged trustees to “please take action now”, warning that waiting to be "too precise" could be the enemy.

“Don’t leave it a couple weeks, you have to do something now and make decisions, so speak to your advisers,” he continued.

“You just need to make some decisions that at least go in the right direction, as that collateral position really needs to be bolstered up for the 14 October, when the Bank pulls out its support of the market.

“We need to be in a position now where these schemes can really weather a significant rise in yields, where it might be double what was expected before.”

This was echoed by Isio head of investment advisory, Nick Evans, who argued that all pension schemes need to “urgently” address their liability driven investment (LDI) strategies before the BofE resumes quantitative tightening.

“There is no doubt there will need to be a fast period of adjustment to this ‘new normal’ and many pensions schemes, their fund managers and consultants will have to put more assets behind LDI with lower leverage in the future,” he continued

“There is a lot that now needs to be done in a short space of time and each scheme’s specific circumstances are different. Some will need to reduce hedging and some will de-risk from return assets to fund more in LDI."

Indeed, speaking to Pensions Age, LCP partner, Dan Mikulskis, explained that while LDI has worked well for last decade, the industry now needs to ensure it is fit for the next 10 years.

“It’s clear we are in a different interest rate environment now to the one we have operated in for the last decade and the industry will need to adapt,” he continued.

“Trustees will wish to ensure these programs are resilient, in particular they will wish to review things like the margin of safety being employed in these strategies, and the operational plans in place to cater for various scenarios. They will need to stress test against a new range of different severe scenarios.”

XPS Pensions chief investment officer, Simeon Willis, agreed that “lessons will have to be learned by the industry”, suggesting that the past week has shone a particular light on the intricacies of managing liquidity when using leverage for risk management purposes, in particular within pooled funds.

“The likely consequences for the fund management industry will be reduction in the levels of leverage within pooled fund offerings, greater communication and processes around collateral calls and prearranged sources of emergency liquidity – such as revolving credit facilities,” she stated.

“Within pension funds it will focus attention on liquidity and will likely lead to greater use of more liquid assets than would otherwise have been the case. Illiquids will still have a valuable role to play in pension scheme strategies, however.”

XPS head of investment, Ben Gold, suggested that this increased caution may also be seen amongst pension schemes, stating that some may want to review whether they are happy to hold leveraged LDI.

"For example, some schemes instead of holding leverage LDI could hold just physical long-dated gills, which would achieve similar levels of hedging, but would be a much blunter tool, and you get a less precise hedge," he explained.

"Pension schemes may well also choose to hold a little bit more liquidity and cash, in case this situation comes back again.

"We're not out of it yet and it wouldn't take very much right now for the market to get spooked and to see a sharp increase in yields again, so I think I think that everyone's sort of mindful of that backdrop."

Speaking to Pensions Age, Cardano head of client solutions, Andrew Stewart, also highlighted a number of practical steps that trustees can take to improve LDI.

In particular, Stewart said that schemes should undertake regular and rigorous scenario testing of their potential collateral calls, to assess whether these are sufficient in periods of market volatility.

He also recommended that trustees establish a robust framework for their ‘cash waterfall’, the order in which you will realise liquid assets if your collateral pool needs to be replenished, explaining that this can speed up decision making when timescales are short.

"This period of extreme volatility has been a test of governance, strategy and implementation," he stated. "There will be a lot to learn, so we’d encourage schemes to undertake post mortems."

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