Category: Investments

Why do pension schemes use liability-driven investment?

Mary Pat Campbell

Link: https://lotsmoore.co.uk/why-do-pension-schemes-use-liability-driven-investment/

Excerpt:

Liability-driven investment allows schemes to invest in the growth assets they need to close the funding gap while reducing the impact of interest rates on the liabilities. This is achieved by assigning a portion of a portfolio to an LDI fund. Rather than this fund just holding gilts, it holds a mixture of gilts and gilt repos.

A gilt repo is re-purchase agreement. The LDI manager sells a gilt to a counterparty bank while arranging to buy back that gilt at a later date for an agreed price. This gilt repurchase agreement provides cash to the pension scheme which it can then use to invest in other assets.

This mixture of gilts and gilt repos in an LDI fund uses leverage to provide capital to the pension fund. It is akin to using a mortgage to buy a house. Different levels of leverage were available in the funds – the more leverage, the greater the ratio of gilt repos to gilts in a fund.

The more leverage in a fund, the less capital a pension scheme had to lock up in government debt and the more it could use to invest in assets which could help to close its funding gap. This was helpful when interest rates were low but became problematic when gilt yields rose.

Author(s): Charlotte Moore

Publication Date: 17 Oct 2022

Publication Site: Lots Moore

Bank of England Bought Only Small Amounts of Bonds even Today, Warns Pension Funds They Have “Only Three Days Left” to Unwind Derivatives with BOE Support

Mary Pat Campbell

Link: https://wolfstreet.com/2022/10/11/bank-of-england-bought-only-small-amounts-of-bonds-even-today-warns-pension-funds-they-have-only-three-days-left-to-unwind-derivatives-with-boe-support/

Graphic:

Excerpt:

The relatively puny amounts of actual purchases show that the BOE is trying to calm the waters around the gilts market enough to give the pension funds some time to unwind in a more or less orderly manner whatever portion of the £1 trillion in “liability driven investment” (LDI) funds they cannot maintain.

The small scale of the intervention also shows that the BOE is not too upset with the gilts yields that rose sharply in the run-up to the crisis, triggering the pension crisis, and have roughly remained at those levels. The 10-year gilt yield today at 4.44% was roughly unchanged from yesterday and just below the September 27 spike peak.

And it makes sense to have these kinds of yields in the UK, and it would make sense for these yields to be much higher, given that inflation has spiked to 10%, and yields have not kept up with it, nor have they caught up with it. And to fight this raging inflation, the BOE will need to maneuver those yields far higher still:

So today, BOE Governor Andrew Bailey, speaking at the Institute of International Finance annual meeting in Washington D.C., warned these pension fund managers that the BOE will only provide this level of support, however little it may be, through the end of the week, to smoothen the gilt market and give the pension funds a chance to unwind in a more or less orderly manner the portions of their LDI funds that they cannot maintain.

Author(s): Wolf Richter

Publication Date: 11 Oct 2022

Publication Site: Wolf Street

Princeton to ‘Dissociate’ Fossil Fuel Investments

Mary Pat Campbell

Link: https://www.ai-cio.com/news/princeton-to-dissociate-fossil-fuel-investments/

Excerpt:

Princeton University’s board of trustees has voted to dissociate from 90 companies as part of an administrative process established last year that focuses on companies involved in the thermal coal and tar sands segments of the fossil fuel industry, or that are engaged in climate disinformation campaigns.

Thermal coal, which is burned for steam and used to produce electricity, was made a priority because it emits significantly more carbon dioxide than alternative available fossil fuels, the university said. It also said that tar sands oil, which is derived from loose sands or sandstone, also produces much higher emissions than conventional crude oil, including in its extraction and production process. However, Princeton said thermal coal and tar sands businesses can be exempt from dissociation if they can prove they can meet a rigorous standard for greenhouse gas emissions.

And in a move to help the university reach its goal of eventually having an endowment portfolio that is net zero of greenhouse gases, the Princeton University Investment Company, which manages the university’s $38 billion endowment, will also eliminate all holdings in publicly traded fossil fuel companies. PRINCO said it will also ensure that the endowment does not benefit from any future exposure to fossil fuel companies.

Author(s): Michael Katz

Publication Date: 6 Oct 2022

Publication Site: ai-CIO

Fiscal Year 2022 Brings Outperformance for Illinois State Teachers’ Retirement System

Mary Pat Campbell

Link: https://www.ai-cio.com/news/fiscal-year-2022-brings-outperformance-for-illinois-state-teachers-retirement-system/

Excerpt:

The Teachers’ Retirement System of the State of Illinois has avoided a significant portfolio downswing despite the equity slowdown that has burdened asset managers with thus far in 2022. Through the second quarter, the fund has returned-1.17% net of fees, a favorable rate of return compared to other public pension systems across the country in fiscal year 2022.

At the end of FY 2022, the 40-year rate of return was 9.3%. This 40-year annualized return eclipses the system’s estimated long-term investment rate of 7%.

The net investment loss will not impact the plans’ ability to pay out benefits to its more than 434,000 members. In 2022, TRS will pay more than $7 billion in benefits to more than 128,000 members and their families.

Author(s): Dusty Hagedorn

Publication Date: 6 Oct 2022

Publication Site: ai-CIO

19 GOP Attorneys General Slam BlackRock Over ESG Investments

Mary Pat Campbell

Link: https://www.ai-cio.com/news/19-gop-attorneys-general-slam-blackrock-over-esg-investments/

Excerpt:

A group of 19 Republican state attorneys general have written a letter to BlackRock stating that the asset manager is using state pension fund assets in environmental, social and governance investments that “force the phase-out of fossil fuels, increase energy prices, drive inflation and weaken the national security of the United States.”

The eight-page letter outlines how the group believes BlackRock is using “the hard-earned money of our states’ citizens to circumvent the best possible return on investment.”

“Our states will not idly stand for our pensioners’ retirements to be sacrificed for BlackRock’s climate agenda. The time has come for BlackRock to come clean on whether it actually values our states’ most valuable stakeholders, our current and future retirees, or risk losses even more significant than those caused by BlackRock’s quixotic climate agenda,” the letter says.

The attorneys general asked BlackRock to respond by August 19.

Author(s): Amy Resnick

Publication Date: 9 Aug 2022

Publication Site: ai-CIO

Louisiana Divests Nearly $800 Million from BlackRock to Protect Fossil Fuel Industry

Mary Pat Campbell

Link: https://www.ai-cio.com/news/louisiana-divests-nearly-800-million-from-blackrock-to-protect-fossil-fuel-industry/

Excerpt:

Louisiana Treasurer John Schroder is divesting $794 million worth of state funds from BlackRock because the world’s largest asset manager’s “blatantly anti-fossil fuel policies would destroy Louisiana’s economy.”

The divestment is in response to BlackRock’s sustainable investing philosophy, and for the firm calling on other companies to embrace net zero investment strategies that would harm the fossil fuel industry, which Schroder notes is a “vital part” of Louisiana’s economy.

“This divestment is necessary to protect Louisiana from actions and policies that would actively seek to hamstring our fossil fuel sector,” Schroder said in a letter to BlackRock CEO Larry Fink. “I refuse to invest a penny of our state’s funds with a company that would take food off tables, money out of pockets and jobs away from hardworking Louisianans.”

When asked to comment, a BlackRock spokesperson said the firm’s view is captured by a line in its Sept. 7 response to a letter it received from a group of 19 Republican state attorneys general saying environmental, social, and governance  investments weaken America’s national security.

Author(s): Michael Katz

Publication Date: 10 Oct 2022

Publication Site: ai-CIO

Louisiana Divests Nearly $800 Million from BlackRock to Protect Fossil Fuel Industry

Mary Pat Campbell

Link: https://www.ai-cio.com/news/louisiana-divests-nearly-800-million-from-blackrock-to-protect-fossil-fuel-industry/

Excerpt:

Louisiana Treasurer John Schroder is divesting $794 million worth of state funds from BlackRock because the world’s largest asset manager’s “blatantly anti-fossil fuel policies would destroy Louisiana’s economy.”

The divestment is in response to BlackRock’s sustainable investing philosophy, and for the firm calling on other companies to embrace net zero investment strategies that would harm the fossil fuel industry, which Schroder notes is a “vital part” of Louisiana’s economy.

“This divestment is necessary to protect Louisiana from actions and policies that would actively seek to hamstring our fossil fuel sector,” Schroder said in a letter to BlackRock CEO Larry Fink. “I refuse to invest a penny of our state’s funds with a company that would take food off tables, money out of pockets and jobs away from hardworking Louisianans.”

When asked to comment, a BlackRock spokesperson said the firm’s view is captured by a line in its Sept. 7 response to a letter it received from a group of 19 Republican state attorneys general saying environmental, social, and governance  investments weaken America’s national security.

Author(s): Michael Katz

Publication Date: 10 Oct 2022

Publication Site: ai-CIO

Bank of England to Treasury, House of Commons

Mary Pat Campbell

Link: https://committees.parliament.uk/publications/30136/documents/174584/default/

Graphic:

Excerpt:

LDI strategies enable DB pension funds to use leverage (i.e. to borrow) to increase their
exposure to long-term gilts, while also holding riskier and higher-yielding assets such as
equities in order to boost their returns. The LDI funds maintain a cushion between the
value of their assets and liabilities, intended to absorb any losses on the gilts. If losses
exceed this cushion, the DB pension fund investor is asked to provide additional funds
to increase it, a process known as rebalancing. This can be a more difficult process for
pooled LDI funds, in part because they manage investment from a large number of small
and medium sized DB pension funds.

Diagram 1 gives a stylised example of how the gilt market dynamics last week could
have affected a DB pension fund that was investing in an LDI fund. In this illustrative and simplified example, the left hand side of the diagram shows that the scheme is underfunded (in deficit) before any change in gilt yields, with the value of its assets lower than
the value of its liabilities. More than 20% of UK DB pension funds were in deficit in August
2022 and more than 40% were a year earlier. In this example, the fund is holding growth
assets to boost returns and has also invested in an LDI fund to increase holdings of longterm gilts, funded by repo borrowing at 2 times leverage (i.e. half of the holding of gilts in
the LDI fund is funded by borrowing). The cushion (labelled ‘capital’) is half the size of
the gilt holdings.

The right hand side of the diagram shows what would happen should gilt yields rise (and
gilt prices fall). The value of the gilts that are held in the LDI fund falls, in this example by
around 30%. This severely erodes the cushion in the LDI fund. If gilt prices fell further, it
would risk eroding the entire cushion, leaving the LDI fund with zero net asset value and
leading to default on the repo borrowing. This would mean the bank counterparty would
take ownership of the gilts. It should be noted that in this example, the DB pension fund
might be better off overall as a result of the increase in gilt yields. This is because the
market value of its equity and shorter-term bond holdings (‘other assets’) would not fall
by as much as the present value of its pension liabilities, as the latter are more sensitive
to long-term market interest rates. The erosion of the cushion of the LDI fund would lead the LDI fund either to sell gilts to reduce its leverage or to ask the DB pension fund
investors to provide additional funds.


In practice, the move in gilt yields last week threatened to exceed the size of the cushion
for many LDI funds, requiring them to either sell gilts into a falling market or to ask DB
pension plan trustees to raise funds to provide more capital.

Author(s): Sir John Cunliffe, Deputy Governor, Financial Stability

Publication Date: 5 Oct 2022

Publication Site: UK Parliament

Stable Fund Focus in Another Excessive Fee Suit

Mary Pat Campbell

Link: https://www.napa-net.org/news-info/daily-news/stable-fund-focus-another-excessive-fee-suit#.Y0F5DNPIdlA.linkedin

Excerpt:

The latest excessive fee suit targets “wildly excessive compensation,” an allegedly imprudent stable value offering, and the unmonitored use of “float” income. 

More specifically, the participant-plaintiffs of Miami, Florida-based Lennar Corp. are raising issues with the recordkeeping/administrative fees (“wildly excessive compensation”) paid by the plan, the prudence of retaining Prudential’s stable value fund, and the use of float income by Prudential (the plan’s recordkeeper). 

The lawsuit, filed in the U.S. District Court for the Southern District of Florida (Catenac v. Lennar Corp., S.D. Fla., No. 1:22-cv-23232, complaint 10/5/22), is directed at a plan with approximately $1.2 billion in assets and nearly 13,000 participants. The participant-plaintiffs are represented here by Morgan & Morgan PA.   

Author(s): Nevin E. Adams, JD

Publication Date: 6 Oct 2022

Publication Site: NAPA-net

Editorial: No Crypto in 401(k)s

Mary Pat Campbell

Link: https://www.toledoblade.com/opinion/editorials/2022/10/08/no-crypto-in-401-k-s/stories/20221004017

Excerpt:

Meanwhile, in Congress the Retirement Savings Modernization Act was just introduced to allow cryptocurrency and just about anything short of lottery tickets into America’s 401(k) accounts. The alternative asset industry — private equity, hedge funds, venture capital, real estate, and more — has been trying for years to offer their speculative products — and reap huge fees in the process — through personal retirement accounts as they are already able to do in some public pensions, such as Ohio’s.

There has been no legal barrier to these investments, and the Trump administration’s Department of Labor went so far as to specify that alternative investments could be part of 401(k)s, a decision affirmed by the Biden Administration. But companies administering 401(k) accounts are fiduciaries, and they’ve avoided alternative investments in fear of getting sued for breach of fiduciary duty for offering them to workers. For decades, prudence has prevailed and 401(k) retirement accounts have not allowed high-fee, illiquid funds as a 401(k) option.

The proposed bill simply states that alternative investments, despite the higher fees associated with them, are “covered” investments that do not establish fiduciary breach by their presence in a 401(k) plan. The cloak of congressionally created cover for alternative investments is needed because the current commonsense assumption is that the mere presence of these investments is strong evidence fiduciary duty has been breached.

Author(s): Blade Editorial Board

Publication Date: 8 Oct 2022

Publication Site: Toledo Blade

U.K.’s LDI-related turmoil puts spotlight on use of derivatives

Mary Pat Campbell

Link: https://www.pionline.com/pension-funds/uks-ldi-related-turmoil-could-spread-experts-say

Graphic:

Excerpt:

The Bank of England’s emergency bond-buying last week helped shore up U.K. pension funds and threw a spotlight on a popular strategy among corporate plans known as LDI – or liability-driven investing.

Total assets in LDI strategies in the U.K. rose to almost £1.6 trillion ($1.8 trillion) at the end of 2021, quadrupling from £400 billion in 2011, according to the Investment Association, a trade group that represents U.K. managers. Many LDI mandates allow for the use of derivatives to hedge inflation and interest rate risk.

….

Here’s how LDI works: Liability-driven investing is employed by many pension funds to mitigate the risk of unfunded liabilities by matching their asset allocation and investment policy with current and expected future liabilities. The LDI portion of a pension fund’s portfolio utilizes liability-hedging strategies to reduce interest-rate risk, which could include long government and credit bonds and derivatives exposure.

Jeff Passmore, LDI solutions strategist at MetLife Investment Management, said the situation with U.K. pension plans “has been challenging, and the heavy use of derivatives in the U.K. LDI model has made the current situation worse than it would otherwise be.”

While most U.S. LDI portfolios rely on bonds rather than derivatives, ‘”those U.S. plan sponsors who have leaned heavily on derivatives and leverage should take a cautionary lesson from what we’re seeing currently across the Atlantic.”

….

The U.K. pension debacle “is a plain-and-simple problem of leverage,” Charles Van Vleet, assistant treasurer and chief investment officer at Textron, said in an email.

Many U.K. pension plans were interest rate-hedged at 70%, while also holding 60% in growth assets, suggesting 30% leverage, he said. The portfolio’s growth assets have lost around 20% of value if held in public equities and fixed income or about 5% down if held in private equity, he noted.

“Therefore, to make margin calls on their derivative rate exposure they had to sell growth assets – in some cases, selling physical-gilts to meet derivative-gilt margin calls,” Mr. Van Vleet said.

“The problem is worse for plans who gain rate exposure with leveraged ETFs. The leverage in those funds is commonly via cleared interest rate swaps. Margin calls for cleared swaps can only be met with cash – not posted collateral. Therefore, again selling physical-gilts to meet derivative-gilt margin calls.”

Author(s):

BRIAN CROCE
COURTNEY DEGEN
PALASH GHOSH
ROB KOZLOWSKI

Publication Date: 5 Oct 2022

Publication Site: Pensions & Investments