LDI – Surf’s Up!!!
Whether you are a beach bunny or scared of the water, the last week in pensions investing has been “one hell of a ride.”
How your scheme coped with the big investment waves and the inclement weather will depend significantly on how much you use LDI in your investment strategy and how your collateral waterfall responded to the rising surf.
At the heat of the market turmoil, for those using LDI strategies to hedge out interest rate and inflation risk, the waves were crashing into shore. For thrill seekers with big LDI positions and the best surfing equipment there were some serious waves which required real skill to ride. For others with similar LDI strategies but less good surf kit the fear of being dashed on the rocks was the more prevalent emotion.
A few weeks ago, we issued a news item to clients suggesting that they re-examine their LDI decisions against a high inflation and high interest rate environment. This was not to suggest that LDI strategies should be unwound. Instead, it was to sense check and stress test LDI in a higher interest rate environment which was not fully contemplated when the original decisions were made. It was to make sure the collateral waterfall and its governance is robust.
From what we have been seeing, those schemes which sense checked their LDI and shored up their collateral waterfalls before the ill-winds of the mini-budget arrived effectively up-graded their surf kit and seem to have ridden the big waves reasonably well – although it was not always a comfortable ride. Many others were able to get into the water quickly without pre-planning, but their surfing style was not as elegant as usual. We suspect that some will have come off their unwaxed surf boards and swallowed lots of salty water in the process.
We do not know what will happen on the 14 October when the Bank of England’s intervention in the gilts market is due to end. Will the winds whip up the waves again for another spell of “high adrenalin surfing” or will they be a gentler experience? Either way it pays to prepare. Investing in time with your investment consultant to assess the quality of your surfing kit whilst we are in a lull may well prove to be a worthwhile exercise.
For those who have not used LDI strategies, last week must have felt like a complete vindication of that decision. Without the need to post collateral, riding the big waves using the cutest surf kit and with the ease of an ultimate “bronzed California surfing dude” must have been a more satisfying experience. But being able to ride last week’s big waves does not mean that all waves will be as easy to navigate. The gains made over the last week can be lost just as easily if yields reverse as sharply as they rose. For schemes without LDI, maybe the rough surfing has yet to come. The challenge is to work through with your investment consultant the extent to which you can lock into the funding gains of last week. Having won the “surf dude” trophy, keeping it could prove to be more difficult over the coming weeks.
The only schemes who are not in the water are those with a full buy-in. Sunning themselves on the beach, licking an ice cream and watching the waves and surfers roll in is about as stressful as it got for those schemes.