U.K. Regulator Pushed Pensions to Load Up on LDIs

The derivatives-based investment strategy that tipped the U.K.’s pension sector into crisis started with good intentions: Help companies fulfill promises they made to employees to pay a steady income through retirement, the Wall Street Journal reported. Behind the push into that strategy, say pension trustees and their advisers, was the Pensions Regulator, the U.K.’s powerful watchdog, charged with safeguarding the savings of millions of private-sector workers. The regulator steered private pension funds to adopt liability-driven investments, known as LDIs, linked to returns on U.K. government bonds, according to pension trustees and consultants. The rush into the strategies concentrated risks in the market. It was, analysts say, the financial equivalent of a crowded room during a fire alarm. When government-bond yields surged, everyone rushed for the exits. The resulting mayhem made the situation even worse and prompted a Bank of England rescue of the bond market. In conversations with trustees, the regulator would tell funds they needed to lower their risk to big swings in the markets by increasing exposure to U.K. government bonds, known as gilts. Gilts are considered safe, like Treasurys. But because yields on them were low in the slow-growth years after the financial crisis, holding more of them exacerbated the shortfalls pension plans forecasted to pay retirees far in the future. A solution was to own LDIs instead. They invest in interest-rate swaps and other derivatives that are tied to gilts. But because they typically use leverage, they free up the pension fund’s balance sheet to invest in other higher-yielding investments such as stocks, private equity or real estate. Read more. (Subscription required.)