The crisis in longer-dated UK government debt in the autumn of 2022 exposed shortcomings in the resilience of liability-driven investment (LDI) and the operational processes of the pension schemes using this approach.
The inability of some schemes to meet margin calls in a timely manner raised serious questions about the effectiveness of their interest rate and inflation hedges. The crisis is likely to have a longrun impact on the way defined benefit (DB) pension funds manage the liquidity of their assets.
Yield rises and strains on LDI
The dramatic autumn sell-off in UK government bonds drove 30- year conventional yields to over 5 percent and caused the one-year decline in the price of the long-dated (2073) index-linked gilt to exceed 90 percent—a performance worthier of a failed dot.com stock or a cryptocurrency than a notionally "gilt-edged" security.
An intervention by the Bank of England, involving temporary purchases of long-dated gilts, helped bring down yields and stabilise the market.
However, the dramatic interest rate moves caused unprecedented strains on the defined benefit pension schemes involved in LDI.
By using LDI, pension schemes can manage the funding risk caused by changes in interest rates and inflation. The leverage embedded in LDI means pension schemes do not have to pay the full upfront cost of the fixed income portfolio required to hedge these interest rate and inflation risks (this is because LDI causes the schemes' assets to move in a similar direction and magnitude to the present value of future pensions obligations).
This post was funded by T. Rowe Price
For professional clients only. Not for further distribution.
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
It is not intended for distribution to retail investors in any jurisdiction.
This material is issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
© 2023 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.