FT. It is beyond ironic that an investment strategy that claimed to eliminate risk threatened the unprecedented failure of the UK pension system this week. The main focus of attention so far in probing what went wrong has been on what took place over the few days leading up to the Bank of England’s emergency intervention on Wednesday to stem a crisis in pension funds over so-called liability driven investment strategies.
These strategies aim to hedge the liabilities of funds to meet their pension promises with the use of derivatives. But they suddenly exposed the sector to a now infamous “doom loop”, when falls in gilt prices triggered calls on schemes to provide more collateral on such trades, in turn spurring more sales of UK government bonds to raise cash. (…)
The pursuit of zero risk led to a massive and permanent change in pension funds’ asset allocation — the proportion of their funds invested in bonds increased ffom less than 20 per cent in 2000 to 72 per cent in 2021. The Investments in listed UK equities declined steadily, from 50 per cent of their asset allocation in 2000 to 4 per cent in 2021. (…)
Tragically, we have ended up with an emasculated system that is unintentionally self-destructive and, as this week has shown, still remains vulnerable. If anything good is to come out of this latest crisis, it is hopefully a recognition that, rather than a few tweaks here and there, we must now change this system root and branch, once and for all.
The UK government should as a matter of urgency commission an official inquiry into both how the nation’s pension savings system could have been put at such extreme risk and what steps need to be taken to ensure that this can never be allowed to happen again.
(Michael Tory, Ondra Partners)
