After former chancellor Kwasi Kwarteng’s mini-Budget on 23 September, global markets reacted rather vociferously.
Mr Kwarteng’s historic, £45 billion tax-cutting package was designed to execute the “dash for growth” economic plan laid out by now former prime minister Liz Truss.
Instead, the decisions spooked investors, causing great volatility across the UK economy: according to Yahoo News, there was a 2% decline in the FTSE 100 the day after the mini-Budget, while the Evening Standard reported that the pound had hit an all-time low just three days later.
In the wake of the chaos, you may have seen the headlines about the Bank of England (BoE) stepping in to buy government bonds. As reported by CNBC, the BoE said that this move was taken to prevent the imminent collapse of defined benefit (DB) pension schemes that were just “hours from disaster”.
So, why did the BoE step in? And was your pension ever at risk? Read on to find out more.
Government bond values fell as yields rose
Government bonds, also sometimes known as “Treasury bonds” or “gilts” in the UK, are loans that the government can issue to raise money.
Both institutional and individual investors can buy gilts from the government’s Debt Management Office, essentially taking on this debt. In return, they are paid regular interest (known as the “coupon”) throughout the term of the bond. Conventional gilts typically last for five, 10, or 30 years and, after the bond expires, investors then receive their initial investment back.
A key metric that investors consider when buying bonds is the “yield”. This is a figure expressed as a percentage that represents the return of the gilt, and is calculated by dividing the annual coupon by the price of the bond.
Investors and funds are also free to sell gilts on a secondary market, forgoing the regular payments for an instant return that is, ideally, more than they initially paid for the bond. The buyer then receives the coupon payment instead.
In general, gilts are seen as a secure investment as the UK is an excellent credit risk – it would usually require the entire government to financially collapse for bond holders to not receive their money.
However, after Mr Kwarteng’s speech, investors foresaw an increase in government borrowing to fund the newly announced tax cuts. In turn, they began selling gilts in fear of what was to come.
As investors sell gilts, that sees supply increase in the market, reducing the value of each bond. The issue with this is that bond prices and yields move inversely to one another – that is, as the price falls, yields rise because the coupon represents a greater proportion of the gilt’s value.
Rising bond yields are typically a sign that investors have become unwilling to own the bonds.
DB pension funds often hold gilts as a risk management strategy
The crux of this issue for pensions was that falling prices and rising yields presented a potential problem to DB pension funds.
The majority of DB funds pursue a strategy known as “liability-driven investing” (LDI), focusing investment policy on meeting their obligations over long periods. They do this because their liabilities and how much they will need to pay out to their members will vary over time – they might be required to pay out £10 million in one year, and then £15 million in the next.
Gilts are often central to this LDI method, as they are generally a reliable source of income over the long term. But rather than the pension schemes buying and holding gilts themselves, they will instead invest in gilt derivatives provided by major fund managers. This might include firms such as Legal & General, Insight, and BlackRock.
Pension funds then post cash as collateral to the fund managers to cover these positions, in the event that the market moves in the wrong direction.
If gilt holders all sell their bonds are one time, it causes the value of them to drop rapidly, sending yields up. This is exactly what happened in this instance, requiring the pension providers to provide additional collateral to cover their positions as gilt values dropped.
This presented a liquidity issue for DB funds, as they needed cash to pay the banks and LDI funds. Knowing that it would require them to raise cash rapidly, this is where the source of concern for funds being at risk of collapse came from.
For many scheme providers, it forced them into selling gilts at decreasingly competitive prices, deepening the issue and creating a vicious cycle in which more schemes had to sell to meet their obligations, and so on.
The BoE had been buying up to £10 billion of gilts each day
To steady the gilt markets amid the turbulence of rising yields, the BoE announced on 28 September that it would be stepping in.
From 28 September to 14 October, the Bank initially pledged to buy up to £5 billion of UK gilts each day. The Bank then subsequently raised this daily limit to up to £10 billion on 10 October.
In practice, the BoE rarely got too close to these limits. Some of the highest total purchases on a single day included:
- £1.025 billion according to Reuters on 28 September
- £1.415 billion on 29 September
- £4.4 billion according to the Financial Times on 12 October.
In doing so, the BoE increased demand in the market, in turn pushing up the price of gilts as a whole. This ultimately gave the pension funds the much-needed cash required to remain afloat and able to continue providing their stakeholders with their funds.
Your pension was likely never really at risk
This brings us back to the central question behind this issue: was your pension ever at risk? The answer depends largely on who you ask.
Your scheme provider most likely experienced an issue of liquidity – in that they needed access to cash in the short term – rather than the schemes themselves and your funds within them in any immediate danger of being lost.
Indeed, as reported by Professional Adviser, the government body responsible for regulating work-based pension schemes, The Pensions Regulator (TPR), was quick to dispel the risk presented to those with DB pensions.
Chief executive of TPR, Charles Counsell, subsequently stated that DB pensions “were not and are not at risk of collapse” despite the media frenzy surrounding the issue.
The crucial outcome of the uncertainty surrounding gilts and pension funds last month is that funds did not collapse. So, while it might have seemed like a crisis at the time, you can rest assured that these events did not cost you your retirement savings.
Speak to us
If you’d like help with any element of your pension or retirement planning in general, please do get in touch with us at Rosebridge.
Email firstname.lastname@example.org or call 01204 300010 to find out more.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
Workplace pensions are regulated by The Pension Regulator.