“Last week was the week in which the investment strategies of defined benefit schemes became a focus of national conversation and led to intervention from the Bank of England to support the UK gilt market. While events of recent days have highlighted strains on DB schemes, the overall picture regarding their funding position and ability to derisk is more nuanced and in many cases more positive than headlines might suggest.
“For schemes looking to derisk this week’s rising gilt yields have pushed insurance pricing down, but this has been accompanied by a fall in the value of their LDI funds. The extent to which these opposing trends impact on affordability for Schemes to undertake buy-in or buy-out activity will depend on the degree of matching between the assets that insurers use to back their quotations and scheme assets. Schemes are often under hedged relative to insurer pricing portfolios, meaning this yield rise will be beneficial. However, once yields start moving the other way this will have the opposite effect.
“Over the past few days Schemes have been forced sellers of assets to meet margin requirements in cash, liquidating gilts and credit would exacerbate any mismatch between insurer pricing and Scheme assets. While yields continue to rise this is not an issue, but Schemes will want to re-balance exposures when possible, and hopefully before rates begin to fall, or act to insure if they have benefited from short term market movements.
“The spike in sale of gilts, and as a result the rapid decline in the price of gilts, is largely due to these margin calls within Scheme LDI portfolios. This shock to the gilt market is what led the BoE to restart its gilt purchase program in order to stabilise the market while supply outstrips demand, minimising the fall in gilt prices and the impact on Scheme funding positions.”
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