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

Notepad_Phil

Linton said:

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

No idea, but annuities are 100% protected by the FSCS, so if you've got one then it wouldn't be a problem, but I guess if you're worried that annuity rates might be lower in the future then that might be an issue.

Nebulous2

Linton said:

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

Who knows what else is lurking out there? 

I saw a quote recently from Andy Haldane, which I can't find now, to the effect that we have cleaned up the banking system but there was a possibility that risks had moved to less regulated parts of the financial system. The pension debacle suggests he could be right... 

biscan25

Linton said:

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

Insurance companies would be hammered by capital requirements if they used derivatives in this way to match their liabilities.
They would effectively have to hold huge amounts of cash as well as these derivatives, which would affect their bottom line.
Instead they hold gilts, corporate bonds and money market instruments.

As an aside, pension funds are unlikely to go bust. The armageddon scenario is the LDI provider kicks them out of their interest rate hedge if they cannot provide the capital due to having insufficient liquid assets to sell . Then if gilt yields subsequently go down before they can restore the hedge, they are exposed to these movements as their liabilities will go up by more than their assets.

In any case, should a shortfall arise, the sponsoring employer/s is ultimately responsible for making this up (eventually). Only when the sponsor also fails whilst the scheme is underfunded does a scheme fall into the PPF and members get reduced pension benefits.

Altior

Deleted_User said:

In personal finance, whether you can afford debt, including in adverse circumstances, is the right kind of question to consider.

For government debt, the standard narrative that we should ask the same question, "where is the money coming from?", is completely misleading. Of course there are consequences from large "unfunded" tax cuts, mostly going to rich people, in terms of inflation in goods & services, and inflation in asset prices, and exchange rate changes, and more simply in terms of a further upward redistribution in wealth (with this working in the same direction as other current factors, such as high energy prices, and sub-inflation pay rises). But how it will be funded is a non-issue for a government that issues its own currency and has floating exchange rates: rich people will simply collectively end up holding more government-issued tokens (whether that is cash or gilts).

The false narrative may even be exactly what Truss and Kwarteng want, because it implies that they can "fix" the problem by making huge cuts to public spending, which is clearly exactly what they want to do anyway. And that will have even worse effects in impoverishing ordinary people and making rich people richer.

What does the term unfunded tax cuts even mean. What's meant to happen is that everybody of working age contributes a little of their earnings and wealth, in return for the state providing certain services assurances, and insurances.

When was the last time that government spending was entirely funded by the tax revenues it collects from us, and from business?

I definitely recall many commentators in recent history claiming that it doesn't matter how much the country goes into debt when interest rates were close to zero. They appear to be the same people now moaning about peoples' mortgage interest rates going up to 5%, and the currency 'collapsing'!

Hopefully you agree that all government expenditure should be funded by the revenue it collects. Since it sounds like you believe only taxing an individual 40% of their earnings instead of 45% means the theoretical loss of the extra 5% from slightly reducing the punitive marginal rate needs to be funded by somebody else. 

This is not really a 'political' argument, more of a cultural one, as recent events have exposed the weaknesses in modern society. All mainstream political parties in the UK are now essentially social media / dinner party / twitter people pleasers, and the incredible media reaction to some of them finally trying to change the course and the narrative a little bit is very telling. Demonstrated by half the MP's exhibiting faux outrage because mortgage interest rates are now finally normalising.

Unfortunately the dubious practices in the pension funds area exposes another major issue in our modern society. Industry regulators who are either incompetent or biased toward the very people they are meant to be regulating. Likely, a bit of both. 

Altior

bostonerimus said:

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.

Definitely depends up personal preferences, to an extent.

Hypothetically, would you rather retire with no capital and no mortgage, or £100K mortgage liability and £200K cash in the bank. 

There are other considerations, but I would much rather have access to the cash, as it provides many more options. Including, an income. 

Obviously one would plan to have access to more capital at retirement, I just used that as a simplistic example. And if you've been holding the mortgage for a long period of time, the repayments are likely to be minimal in real terms. That's why for me at least, TVM is a significant consideration. 

NedS

biscan25 said:

Linton said:

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

Insurance companies would be hammered by capital requirements if they used derivatives in this way to match their liabilities.
They would effectively have to hold huge amounts of cash as well as these derivatives, which would affect their bottom line.
Instead they hold gilts, corporate bonds and money market instruments.

As an aside, pension funds are unlikely to go bust. The armageddon scenario is the LDI provider kicks them out of their interest rate hedge if they cannot provide the capital due to having insufficient liquid assets to sell . Then if gilt yields subsequently go down before they can restore the hedge, they are exposed to these movements as their liabilities will go up by more than their assets.

In any case, should a shortfall arise, the sponsoring employer/s is ultimately responsible for making this up (eventually). Only when the sponsor also fails whilst the scheme is underfunded does a scheme fall into the PPF and members get reduced pension benefits.

Great answer.

In answer to @Linton yes, annuity providers may also be affected if they have used LDIs, and there is no reason that cannot so if I were a betting man, I'd assume at least some have tried to be greedy.

L&G were very quick to come out and say they were not affected:

https://www.sharecast.com/news/news-and-announcements/legal-general-says-investment-arm-not-exposed-to-ldi-turmoil--10889530.html

although they are one of the market's biggest sellers of LDIs:

https://www.lgim.com/uk/en/capabilities/investment-strategies/liability-driven-investment/

but I guess they are not the one's left without a seat once the music stops.

bostonerimus

Altior said:

bostonerimus said:

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.

Definitely depends up personal preferences, to an extent.

Hypothetically, would you rather retire with no capital and no mortgage, or £100K mortgage liability and £200K cash in the bank. 

There are other considerations, but I would much rather have access to the cash, as it provides many more options. Including, an income. 

Obviously one would plan to have access to more capital at retirement, I just used that as a simplistic example. And if you've been holding the mortgage for a long period of time, the repayments are likely to be minimal in real terms. That's why for me at least, TVM is a significant consideration. 

What about having no mortgage and 100k in the bank? My last mortgage was a 15 year fixed at 3% (I'm in the US where you can lock in rates for 15, 20 or even 30 years). I made sure my retirement investing was funded sufficiently and then paid down my mortgage. All the pensioners who are now looking at renewing their mortgages at 6% probably regret not making extra payments at 2%.

phillw

bostonerimus said:
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 kinda regret not saving/investing the money somewhere else at > 2% instead of paying the mortgage off.

A mortgage fixed for the entire term of the mortgage would be quite dreadful.

Linton

phillw said:

bostonerimus said:
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 kinda regret not saving/investing the money somewhere else at > 2% instead of paying the mortgage off.

A mortgage fixed for the entire term of the mortgage would be quite dreadful.

Why would a fixed lrate mortgage be dreadful?  It would make planning much easier and remove the fear of unaffordable increases.  The pain of having to pay more than you planned surely exceeds the pleasure at paying less.

I believe totally fixed rate mortgages are common in the US and becoming available here.  Lifetime fixed rate is normal for retirement mortgages.  I have a fixed 3% mortgage for the rest of my life.  It is roll-up ER but I could pay the interest if I wanted  to.

bostonerimus

phillw said:

bostonerimus said:
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 kinda regret not saving/investing the money somewhere else at > 2% instead of paying the mortgage off.

A mortgage fixed for the entire term of the mortgage would be quite dreadful.

Surely having the option to fix the rate long term would be nice because it means you should always be able to afford it. There is a lot to be said for stability. Anyway in the US you can always refinance (for a fee) at anytime. The thing is to spread your money around so you minimize the risk of a single sector/investment type from failing. With hindsight we can all come up with the optimum investment scenario, but we have to deal with the uncertainty of the future so a bit in stocks, some in bonds, some in cash and some invested to pay off the mortgage is prudent IMO. Hopefully the house will also get some capital appreciation and I'd rather be mortgage free right now than having to make mortgage payments with money in a falling market, particularly if the mortgage rate is >6%.