BlackRock – Portfolio Insight


off in real rates last year was a benefit for most pension schemes.


That is good context, but there were tu- multuous events in September and October.


The volatility in September and October was unlike anything seen before in the in- dex- linked gilt market. In a single day, the yield on long-dated gilts jumped more than 70 basis points, which had a huge impact on value.¹


If, for example, the duration of these gilts is 30 years, that would have been approxi- mately a 20% shift in the value of their li- abilities within a day. We have never seen anything like that before. We had several of these big shifts, in the same direction, on consecutive days.


The largest single day movement prior to September and October, was in the order of 30 to 35 basis points.¹ This means that when pension schemes hedge through entering into swap contracts or repur- chase contracts with banks, they are lock- ing in a particular rate. If the market rate goes up, then the pension scheme has to post collateral to the bank. If the market rate goes down, the bank has to post col- lateral to the pension scheme. For decades the move has mainly been down, so banks posted collateral to pen- sion schemes. But in September and Oc- tober last year, yields went up a lot and pension schemes needed to post collater- al to the banks.


The way these portfolios were generally managed meant that they could stand real rates moves that were significant com- pared to pre-Autumn-22 market condi- tions. But during the height of the volatil- ity, the collateral buffers held were equivalent perhaps to only a few days’ worth of movement. The difficulty came when schemes had to find additional col- lateral to sell quickly. Moreover, no one knew when the increases would end. A scheme may have had enough cash or gilts to withstand a yield rise of 150 basis points, but if it was more than that, they


needed to sell other assets to post them as collateral. That is what caused the difficul- ty. It was a liquidity issue rather than a funding issue. Within a few days, gilt yields rose 200 ba- sis points. Then, on 28 September, the Bank of England announced it was going to support the market through purchas- ing gilts up to a certain limit each day. That calmed the market and yields fell considerably. Then they went up. Then they went up again.


The Bank of England then announced that rather than just buying conventional gilts, it would buy index-linked gilts, which calmed the market and yields fell. There were changes at the top of govern- ment, calming statements were made and the market settled.


What are your takeaways from the impact on defined benefit schemes’ collateral? If schemes couldn’t find the cash to post, they had to take a risk or reduce their hedge. If that happens – and you only temporarily want to take it off – you likely do it when it is cheap and replace it when it is more expensive. This could cause an element of underperformance. There may also be broader impacts from selling other assets to generate collateral. Look- ing at the longer-term impact, thinking of LDI portfolios we expect an increase in a scheme’s collateral buffer, especially as


the Bank of England’s policy committee had made noises in that direction. And in April, that is what happened when The Pensions Regulator released guidance for a market stress buffer of at least 250 basis points as well as a further Operational Buffer to increase resilience.² There is also the issue of less leverage in pension schemes. They do not need as much as they had before due to improved funding levels. As funding levels have im- proved, schemes may choose to have more lower risk investments. And another big point is governance. If you are a big scheme with a lot of resourc- es then you have people who make sure assets are sold and cash is posted when needed. If you are not, then you need pro- cedures to make sure those people are available if needed. They will have to spend significant amounts of time on these events, should something of the same magnitude happen again. This is driving consolidation of one sort or another. It could be consolidation in terms of OCIO [outsourced chief invest- ment officer]. Moreover, as an alternative, some schemes are giving LDI managers more assets to manage, so they can access these quickly and directly in times of mar- ket stress. The outcome here could be some form of what we call a collateral


waterfall


The volatility in September and October was unlike anything seen before in the index-linked gilt market.


1) BlackRock, as at 31st December 2022 2) The Pensions Regulator, 24 April 2023


Issue 124 June 2023 | portfolio institutional | 29


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56