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The UK’s LDI crisis: lessons for Dutch LDI investors

The UK’s LDI crisis: lessons for Dutch LDI investors
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ARTICLE TYPE
Research
TOPIC
Solutions
PUBLISHED
November 02,2022
READ TIME
5 mins
AUTHOR
Oliver Warren
Yiyi Huang
SHARE
Back
ARTICLE TYPE Research
TOPIC Solutions
PUBLISHED November 02,2022
READ TIME 5 mins read
AUTHOR Oliver Warren
AUTHOR Yiyi Huang
SHARE

The world of Liability Driven Investment (LDI) strategies, one where “boring” is generally viewed as a strong selling point, became headline news in the UK last month. The much-awaited shift away from a low rate environment – generally a good development for pension schemes’ funding positions – came rather too rapidly for many, so much so that the Bank of England became worried about systemic risk and decided to step in to stabilise the gilt market. This article looks at some of the background to what has happened and seeks to answer the question which may concern many Dutch pension scheme investors – could this happen to them too?

 

Figure 1: 20-year gilt yields versus Euribor swap yield and US treasury yield20-year-gilt.jpgSource: Bloomberg & Aegon Asset Management. As at 31 October 2022.

Our conclusions

The speed of rises in gilt yields seen in the UK cannot be ruled out in the eurozone but is probably less likely for several reasons:

  • The broader base of the eurozone economy;
  • The eurozone’s fiscal rules and mechanisms restricting the kind of tax giveaways which were proposed in the UK;
  • The relative importance of the euro for global investors versus the pound;
  • The notable importance of UK pension funds as holders of long-term gilts in the British economy.

 

Dutch pension schemes are, in general, in a better position than their UK counterparts:

  • The relatively large size of Dutch pension schemes, on average, means most will have the resources to have smooth and well-organized collateral management processes;
  • The popularity of fiduciary managers in the Netherlands means collateral management is generally organized by one party, rather than being a process involving pension schemes, their investment consultant and their asset managers;
  • Many UK pension funds have very high interest rate hedging levels due to a trend to reduce risk in preparation for buy out;
  • Dutch LDI managers have generally been conservative in the leverage levels offered;
  • Dutch LDI managers also often require direct access to other highly liquid scheme assets whereas many UK LDI managers will have needed to request collateral calls from the pension schemes.

 

Despite these points, Dutch pension schemes will no doubt want to review their current position. Testing their collateral management process against a scenario similar to that seen in the UK is an obvious stress scenario to consider.

 

 

Important disclosures

Aegon AM - UK LDI crisis.pdf

(319KB) PDF

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More about the authors

Oliver Warren Senior Investment Solutions Consultant

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Yiyi Huang Senior Investment Solutions Consultant

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