Pensions decimated

[TheBrit]

Great article, but it does confirm basically what I am saying.

It is more like the opposite. You thought they were trying to increase returns & risk. That was my first thought as well. However, they were doing the opposite and trying to reduce volatilty risk. Obviously the mechanics used were imperfect but do branch out from some of the links in that article and look around the idea of LDI a bit more.

[qhank]

It is more like the opposite. You thought they were trying to increase returns & risk. That was my first thought as well. However, they were doing the opposite and trying to reduce volatilty risk. Obviously the mechanics used were imperfect but do branch out from some of the links in that article and look around the idea of LDI a bit more.

To be honest no one knows exactly what they were doing. But the sheer scale of the movement suggests that they were over-leveraged. The FT article suggests that some were doing a leverage of up to 7 times, that is, starting with 100 pounds but ending up with exposure to 7 times that in long-dated gilts.

If true then it's hardly a surprise that they got burnt when long-term interest rate starts moving up.

Bond traders were doing exactly the same thing in China a couple of years ago and they got burnt badly too.

[freeier]

To be honest no one knows exactly what they were doing. But the sheer scale of the movement suggests that they were over-leveraged. The FT article suggests that some were doing a leverage of up to 7 times, that is, starting with 100 pounds but ending up with exposure to 7 times that in long-dated gilts.

If true then it's hardly a surprise that they got burnt when long-term interest rate starts moving up.

Bond traders were doing exactly the same thing in China a couple of years ago and they got burnt badly too.

ya the numbers prove otherwise. technical margin call on CF.. even if its completely wrong, we are talking about say 4% of AUM per year.. barely anything to be concerned with considering the ultra long liabilities profile of pension. A margin call that can affect the market can only be due to liquidation of huge positions...

i think the analysts are reluctant to blurt out the real 'hidden meaning' of those hedges.. if they do the banks will have much lessor business to do.. imagine, 7x leverage.. say in repo.. each layer of repo they make extra spread...

[RobRoy]

It is more like the opposite. You thought they were trying to increase returns & risk. That was my first thought as well. However, they were doing the opposite and trying to reduce volatilty risk. Obviously the mechanics used were imperfect but do branch out from some of the links in that article and look around the idea of LDI a bit more.

I was not fully on the money, but close enough, this article was best so far to describe what happened:

https://www.ft.com/content/f4a728a5-...2-f48e30f8603c

"Generally, when a pension starts putting money into liability-driven investment strategies, it means that it isn’t interested in continuing to watch its pension’s funding ratio swing around with the market.Pensions generally don’t put all their money into LDI strategies at once. Beyond the uncertainty around what they will owe, many are underfunded, meaning they need to put cash into riskier assets to earn a return and make up for that difference.But even when they need to put cash into stocks or other risky markets, they can use leverage (swaps, repo, etc) to match their entire investment portfolio’s duration with the duration of their liabilities."

[qhank]

These strategies largely took off after the global financial crisis, so these positions had never been tested in a period of rapidly rising interest rates, Mr. Mackenzie added.

In other words the chickens have come home to roost. Those who got addicted to zero interest rates are getting burnt.

https://www.wsj.com/articles/pension...es-11664469188

[TheBrit]

[qhank]

According to the WSJ article one of the purposes of LDI is to hedge against falling interest rates:

The LDI strategy is meant to help pensions more efficiently manage their assets to ensure they can pay future retirees. Pensions use an LDI manager, who buys interest-rate swaps and other financial instruments to hedge against the risk that falling interest rates and rising inflation will increase their future obligations.

Oops!

[TheBrit]

To be honest no one knows exactly what they were doing. But the sheer scale of the movement suggests that they were over-leveraged. The FT article suggests that some were doing a leverage of up to 7 times, that is, starting with 100 pounds but ending up with exposure to 7 times that in long-dated gilts.

If true then it's hardly a surprise that they got burnt when long-term interest rate starts moving up.

Bond traders were doing exactly the same thing in China a couple of years ago and they got burnt badly too.

They didn’t get burned - the LDI performed as it was designed. Their assets decreased at the same rate as their liabilities when gilts sold off. If gilts rally their assets will increase alongside their increased liability.

The issues were difficulty posting collateral if there are no bids on gilts it’s hard to sell them…. This was a failure in the market more than anything and the BoE stepped in to provide short term emergency liquidity exactly as you would expect a central bank to do.

Anyway, no pensions are blown up, none were ever insolvent or anywhere near it.

[RobRoy]

The design flaw of the LDI seems to be how the LDI is linked to the same assets the pension funds need to sell off to meet collateral calls.

It creates a pretty death spiral where increasing gilt yield increase collateral demands. After a while the pension fund does not have enough eligible collateral (apparently long duration gilts are not eligible, which I find strange), so they need to sell gilts. This increases the gilt yield, which further increases the collateral needed for posting. Death spiral in full roll..

You could also say, if they didn't leverage the shit out of the LDI and kept more prudent levels, this would also not have happened. But like the article says, they probably did leverage the shit out of it, because they needed to free up a large portion of investments for higher yielding assets. The more allocated to other higher yielding assets, the more leverage in the LDI. Fascinating!

[East_coast]

Classics

https://www.youtube.com/watch?v=U1h4VNFxpGM