Seven days in pensions

The Bank of England effectively admitted that the UK’s economy was now in recession, and it continued its plan to combat rampant inflation by raising interest rates.

Then at 10.30am, chancellor Kwasi Kwarteng gave his short speech outlining a growth package, with swathes of tax cuts and an energy price guarantee scheme, all seemingly unfunded due to the lack of Office for Budget Responsibility assessments.

The pound crashed and gilt yields rose quickly.

The managers called on the Bank of England to do their job. Their job is to ensure the smooth running of the market and, with gilt prices racing for the bottom and yields racing for the top, something had to give

We took an assessment on September 23 and saw that at the front end of the gilt yield curve — yields on shorter-dated government bonds with maturities between two and five years — there were large increases in yields, as the market factored in the impact of a significant wave of new government bonds to be issued (£100bn-plus), in addition to an expectation of further material increases to the bank base rate. A shock, but manageable.

A weekend came and went. While I was at a wedding, the government seemed to be remaining tight-lipped (or perhaps they were at a wedding too) on where the funding for the growth strategy was going to come from. Doubling down on some moves and hinting at more.

Manic Monday

The markets opened on September 26 and there was pandemonium.

By lunchtime that day, 20-year gilt yields were at 4.33 per cent. For our poor actuarial analysts, this was changing by the hour.

To provide some context, we had already seen significant gilt yield rises in the second half of August, followed by a further greater than 0.5 per cent rise over the week prior to the “mini” Budget. This is a far cry from the 1.2 per cent a year yield on December 31 2021, or even the 1.9 per cent a year on March 31 this year.

Schemes were urged to assess their position through September 26-27.

On the face of it, funding levels — all things being equal — were improving rapidly. Schemes that had not looked at their liability value since December may well therefore have been shocked to see that their liabilities had dropped by 50 per cent or more, and even those which had looked more recently will probably have found their liabilities had fallen by more than 20 per cent within the past month.

Of course, assets will have fallen for the well-hedged schemes — that is the trade-off for matching some assets to liabilities.

We were by this time receiving collateral calls from the liability-driven investment managers. Trustees were being asked to:

• Stick by the strategic decision and find some cash to maintain the hedge; or

• Allow the hedge to fall and not provide the additional cash — given the strategic position and the relative price of gilts, this would be a bold move, but no one likes being a forced seller of assets during a recession.

Trustees that had not previously hedged were being advised to look at the position and strongly consider whether now was the time to go in. Hedging has never been so cheap.

There were a myriad tangential issues being raised — cash equivalent transfer values will be much lower, factors recently reviewed may seem out of kilter, annuities suddenly look appetising after years in the doldrums, plus, do not forget, the problem child of inflation is still there. We will be talking about that again when September’s figures are released.

However, we could not get distracted. By the evening of September 27/morning September 28 something went wrong.

Long-dated gilt yields had risen to 5 per cent, another substantial increase. The LDI managers were not getting the cash in fast enough to collateralise their positions.

Schemes — and it is not clear at the time of writing the extent to this — may have experienced a reduction in their hedge if their collateral call had not been met. Please note this is a system that is used to dealing in weeks, not hours.

Managers at panic stations

Everything at the LDI managers had ground to halt. I can only imagine what their weekends and following days had been like but feverish will not cut it.

The managers called on the Bank of England to do their job. Their job is to ensure the smooth running of the market and, with gilt prices racing for the bottom and yields racing for the top, something had to give.

A switching on, albeit temporarily, of the quantitative easing tap got things moving again.

This had an almost immediate effect of clearing the blockage, with yields dropping to 4.2 per cent. There was a lot of work to do to ensure schemes could move funds to hold or improve their hedged positions. But at least the plumbing was now back working.

So here we are on September 30, a week after the chancellor’s speech, hopefully in the calm after the storm with things functioning as they should. However, gilt yields are still very high in the context of recent history and what happens next remains to be seen.

David Brooks is technical director at Broadstone