Why do pension funds need to sell gilts in current environment?

bostonerimus

They basically used leverage to boost their returns. They borrowed money to invest and have had to sell gilts to make payments on that debt and contracts, but gilts have fallen in price and so they are having to sell far more than they expected which can start a run on the market. This is a danger for any organization, fund or individual that borrows money to invest and it's one reason I don't use Investment Trusts ie closed end funds.

NedS

As usual, PensionCraft have an excellent video on the topic explaning it in terms even I could understand

https://www.youtube.com/watch?v=16FUZKQls_E

Millyonare

The UK pensions industry in 2022 loaded up on huge debt and gambled your life savings with debt multipliers of 2-3 times in casino banking on gilts.

Buy £1b of gilts, and "mortgage" them up to £3b. Then, panic when gilt values fall into "negative equity" (due to bad govt) and you are forced to pay back the 3 x debt to the investment banks (that you can no longer afford).

It was basically a repeat of 2008, when the insurance and bank industries gambled your life savings on over-leveraged mortgages (debt).

* 2008 = junk mortgages
* 2022 = junk gilts

Debt... The answer to every financial crisis is always debt... Borrowing more today than you can afford tomorrow.

Altior

mark_cycling00 said:

Imagine you went back in time a month and started telling everyone that LDIs were risky because the government might:

1. commit to borrowing a limitless amount of money to pay people's electricity bills,
2. lower dozens of taxes to create even more inflation
3.forget to publish a plan for how they'd pay for any of it
4. and then on the next day promise to loads more random tax cuts in the future.
5 and on the next day the UK gilt market would collapse like an emerging economy 

Everyone would laugh at you and tell you to wear a tin foil hat.

You'd be right of course but up until 2 weeks ago this scenario was unthinkable for a G7 economy.

It's so ironic that effectively shutting down the economy, paying millions of people to be unproductive for years, locking people in their homes and committing to getting on for half a trillion of borrowing (unlimited when these decisions were made), and years of treasury overspending didn't trigger any such panic or forced selling of gilts. Yet mirroring what many countries have been forced into doing, borrowing to support domestic and business energy consumers due to a global price spike has collapsed the £ and the gilt market. 

Everyone would laugh at you if you said that the Fed have engineered a strong USD in a panic to help mitigate the impact of monumental QE and runaway inflation in their own economy, leading to the cost of borrowing and yields spiking in the US (by far the dominant economy of the world, inevitably leading the way). It just so happened they hiked rates, allied to very hawkish commentary just before the BoE bottled it again, and the 'mini' budget was delivered.

There is no correlation whatsoever of these events though, none at all and GBP would be flying if the government had not stepped in to support people and businesses with a huge energy package, something that the mainstream had been demanding incessantly for weeks. GBP would otherwise have been unaffected by the actions and the deliberate messaging from the Fed. 

bostonerimus

Deleted_User said:

Millyonare said:

Debt... The answer to every financial crisis is always debt... Borrowing more today than you can afford tomorrow.

Not all debt is bad, though. What LDI has in common with securitization of junk mortgages in 2008 is that both involve trying to use financial engineering to invent the holy grail of a high-return but low-risk investment.

Whether debt is good or bad depends on circumstances...a couple of years ago mortgage debt was a great deal at under 2%, today refinancing that debt doesn't look as good. As a matter of personal finance debt should only be used where absolutely necessary ie for a mortgage and then don't gamble on rates and only borrow what you can afford after doing a pretty stringent stress test. All the folks who made extra mortgage payments at 2% to reduce their principal are patting themselves on the back now that rates are at 6% and probably going higher. I've never liked interest only or variable mortgages.

Altior

bostonerimus said:

Deleted_User said:

Millyonare said:

Debt... The answer to every financial crisis is always debt... Borrowing more today than you can afford tomorrow.

Not all debt is bad, though. What LDI has in common with securitization of junk mortgages in 2008 is that both involve trying to use financial engineering to invent the holy grail of a high-return but low-risk investment.

Whether debt is good or bad depends on circumstances...a couple of years ago mortgage debt was a great deal at under 2%, today refinancing that debt doesn't look as good. As a matter of personal finance debt should only be used where absolutely necessary ie for a mortgage and then don't gamble on rates and only borrow what you can afford after doing a pretty stringent stress test. All the folks who made extra mortgage payments at 2% to reduce their principal are patting themselves on the back now that rates are at 6% and probably going higher. I've never liked interest only or variable mortgages.

I'm not sure that there is ever a perfect answer, but often in these types of conversations, TVM is ignored. Commentators often reference inflation or investment growth, but I feel salary growth is the most important variable. If you can increase your income by a bigger percentage than the interest one is paying on the capital, either via improved positions or remuneration, it's better not to overpay and to keep access to the funds that would have been used in the overpayments. Overpaying can of course help with LTV, but if a person hits life difficulties, they are better off having access to relatively liquid capital rather than it being sunk into the mortgage. 

Stress tests are important and should never have been binned, however I'm pretty sure many people modify their behaviour to pass them, such as holding off on children until they have their property. 

bostonerimus

Altior said:

bostonerimus said:

Deleted_User said:

Millyonare said:

Debt... The answer to every financial crisis is always debt... Borrowing more today than you can afford tomorrow.

Not all debt is bad, though. What LDI has in common with securitization of junk mortgages in 2008 is that both involve trying to use financial engineering to invent the holy grail of a high-return but low-risk investment.

Whether debt is good or bad depends on circumstances...a couple of years ago mortgage debt was a great deal at under 2%, today refinancing that debt doesn't look as good. As a matter of personal finance debt should only be used where absolutely necessary ie for a mortgage and then don't gamble on rates and only borrow what you can afford after doing a pretty stringent stress test. All the folks who made extra mortgage payments at 2% to reduce their principal are patting themselves on the back now that rates are at 6% and probably going higher. I've never liked interest only or variable mortgages.

I'm not sure that there is ever a perfect answer, but often in these types of conversations, TVM is ignored. Commentators often reference inflation or investment growth, but I feel salary growth is the most important variable. If you can increase your income by a bigger percentage than the interest one is paying on the capital, either via improved positions or remuneration, it's better not to overpay and to keep access to the funds that would have been used in the overpayments. Overpaying can of course help with LTV, but if a person hits life difficulties, they are better off having access to relatively liquid capital rather than it being sunk into the mortgage. 

Stress tests are important and should never have been binned, however I'm pretty sure many people modify their behaviour to pass them, such as holding off on children until they have their property. 

It's definitely a balancing act and having enough money on hand for emergencies is important, but I look at saving money on interest by making extra mortgage payments (accounting for fees of course) as a guaranteed return, like a saving account. It can be a low risk part of your investments, but it isn't everything and you need sufficient liquidity to live sensibly and take care of emergencies. It's a good thing to do while you are working so that you can go into retirement entirely debt free which takes pressure off your need to generate income. Right now I would hate to be retiring with a mortgage! The markets are down so drawdown will be eating away at your pot faster than possibly planned and if you have to refinance a mortgage that will add to the budget and that's even before the utility and food bills are considered. Anyone who's plan was on the financial edge might well be pushed over it.

Paying off my mortgage was an enormously liberating event both psychologically and practically. I reduced my income needs and gives me the freedom to sell and move more easily and also to buy a house again without using a mortgage.

Millyonare

Deleted_User said:

Millyonare said:

Debt... The answer to every financial crisis is always debt... Borrowing more today than you can afford tomorrow.

Not all debt is bad, though. What LDI has in common with securitization of junk mortgages in 2008 is that both involve trying to use financial engineering to invent the holy grail of a high-return but low-risk investment.

For sure.

But there is low debt, medium debt, and high debt.

Once again, for the second time in under 15 years, the UK finance industry, always so smug, has been brought to the brink of collapse by over-leveraged casino gambling (high debt for pension gilts) that took little to no account of a future inflation, rate-rise, or recession scenario.

What will be the next debt monster from London and Edinburgh and taxpayer bailout in the 2030s?...

Nebulous2

mark_cycling00 said:

Imagine you went back in time a month and started telling everyone that LDIs were risky because the government might:

1. commit to borrowing a limitless amount of money to pay people's electricity bills,
2. lower dozens of taxes to create even more inflation
3.forget to publish a plan for how they'd pay for any of it
4. and then on the next day promise to loads more random tax cuts in the future.
5 and on the next day the UK gilt market would collapse like an emerging economy 

Everyone would laugh at you and tell you to wear a tin foil hat.

You'd be right of course but up until 2 weeks ago this scenario was unthinkable for a G7 economy.

I can't claim to understand all of what has gone on. I certainly struggled to get why a rise in the interest rates was going to cause such an avalanche of selling. 

However - here is an article, which I originally found on mse, written in advance, and raising issues about rising interest rates and LDI. 

So some people were flagging it... 

https://www.portfolio-institutional.co.uk/features/liability-driven-investment-testing-times/

Linton

Are LDIs just a problem for DB schemes or are they also used for annuities?