Much has been written in the last few days about Liability-Driven Investing (LDI) strategies in the UK pensions industry, and the role played by asset managers, including BlackRock.

We’re setting the record straight about the objectives of these strategies, about recent events in UK markets, and our duty to those who are managing the money of those saving for retirement.

We’re setting the record straight about the objectives of LDI strategies, about recent events in UK markets, and our duty to those who are managing the money of those saving for retirement. https://t.co/VNoGdkqeUd pic.twitter.com/Y6KqT6qvRN

— BlackRock UK (@BlackRock_UK) October 1, 2022

Helping to provide savers with financial security when they retire

The money we manage is not our own. It belongs to people from all walks of life who rely on us to act in their best interests. Defined benefit pension plans have to manage their investments so that when their members come to retire, they can meet those expectations.

One of the many challenges these pension plans face is how to ensure that the value of their investments matches the amount they need to pay out to retirees. The value of future pension payments is prone to fluctuations with the rate of measures such as inflation and bond yields, requiring the pension plans to mitigate, or hedge, those risks if they can. The amount retirement plans are expected to pay out to their members in the future are also known as liabilities, and so-called “liability-driven investing”, or LDI strategies, aim to match the value and time horizon of their current assets to those future liabilities.

In recent decades we have been in an environment of low and falling bond yields in the UK. This market environment has meant the present value of those pension fund liabilities – whose amount grows as bond yields fall – was often larger than the value of their current assets (that is, the pension funds had shortfalls; they were in deficit).

One way retirement plans to minimise possible shortfalls is by using some of a given fund’s assets to borrow capital, so that the scheme can invest further to grow the value of their current investments for the benefit of future retirees.

This has been standard practice for many defined benefit retirement schemes in the UK for more than 20 years¹.

Given some pension funds have less assets than liabilities, there is a need for schemes to use borrowing to get both the necessary exposure to liability-sensitive assets as well as exposure to growth assets, like equities, to help make up those shortfalls.

Pension trustees and their consultants determine their own objectives and asset allocation and therefore the amount of exposure to LDI strategies. Asset managers, meanwhile, advise on how to structure and implement those strategies on behalf of their clients – adjusting them so that they continue to be effective in changing market conditions and meet the objective of the pension funds.

What happened between September 23 and 28

As bond yields rise, asset managers like BlackRock periodically ask pension funds to increase the assets in their LDI strategies, if they wish to keep the same exposures.

We are not a trading counterparty to these risk mitigation strategies. 

As UK government bond yields have been rising throughout 2022, asset managers have made such requests dozens of times this year.

But the process takes several days to run, typically more than a week from start to completion.

Normally adjustments to the required assets fluctuate gradually over time, and the amount of excess collateral is more than enough to cover requirements based on previously observed market moves. However, due to the extraordinary moves in UK rates and inflation-linked bond markets over the past week, swift action was needed to protect LDI strategies.

What happened from September 23 – up until the point that the Bank of England announced it would buy long-dated UK government bonds to stabilise the market – was that markets were moving down so fast that there was simply not enough time to get the required assets in to the LDI funds fast enough given how long that process takes.

In these circumstances, BlackRock took steps to protect our client’s interests – and ultimately the value of the investments that future retirees depend upon. We reduced leverage in a small number of multi-client LDI pooled funds, acting prudently to preserve. our clients’ capital in extraordinary market conditions. We sold some assets in a small number of those funds, thereby reducing leverage and reducing the exposure.

Buying and selling of BlackRock’s LDI funds was not halted (or frozen), nor did BlackRock cease trading in UK government bonds.

It is also important to note that while some pension plans have faced calls to increase their assets in their LDI strategies, their solvency was not at issue, given the long-term nature of their liabilities. The rise in bond yields this year – and indeed in the days up until the Bank of England’s intervention – will have in fact enhanced most plans’ funding status.

The Bank of England’s action means the pension and asset management industries can work together to protect the value of pension investments, and to restructure funds to the ultimate benefit of the savers who rely on those funds for their retirement.

BlackRock is committed to helping our clients realise the best outcomes for savers

While pension funds will always want to manage their investments in a liability-aware manner, recent UK market moves may prompt them to consider how their strategies need to evolve.

BlackRock’s purpose is to help more and more people experience financial well-being. We are committed to supporting the UK pensions industry in working through this period of market volatility, to realise the best outcomes for those saving for their retirement.

¹ https://www.pensions-expert.com/Comment/How-LDI-strategies-have-evolved-over-the-past-20-years

Source: BlackRock