LDI strategies: setting the record straight

Much has been written in the last few days about Liability-Driven Investing (LDI) strategies in the UK pensions industry, and the role played by asset managers, including BlackRock.

We’re setting the record straight about the objectives of these strategies, about recent events in UK markets, and our duty to those who are managing the money of those saving for retirement.

Helping to provide savers with financial security when they retire

The money we manage is not our own. It belongs to people from all walks of life who rely on us to act in their best interests. A defined benefit pension plan must manage its investments so that when its members come to retire, it can pay out sums that meet their expectations. These are known as its liabilities.

In recent decades we have been in an environment of low and falling government bond yields in the UK. This market environment has meant the present value of a defined benefit pension plan’s liabilities – whose amount grows as bond yields fall - was often larger than the value of their current assets (that is, this affected pension plans’ funding status: many had shortfalls; they were “in deficit”).

One way pension plans look to minimize possible shortfalls is by using some of a given fund’s assets to borrow capital, so that the scheme can invest in growth assets, like equities, to grow further the value of their current investments for the benefit of future retirees. This has been especially important in the low-rate environment given how little yield has been available from investing in government bonds.

But the value of future pension payments is prone to fluctuations in the rate of measures such as inflation and government bond yields, requiring pension plans to mitigate, or hedge, those risks if they can. This is where “liability-driven investing”, or LDI strategies, come in. The idea at the core of LDI strategies is that a pension plan can match the value and time horizon of its current assets to its future liabilities, while freeing up capital through borrowing to invest in growth assets. This has been standard practice for many defined benefit retirement schemes in the UK for more than 20 years.¹

It is pension trustees and their consultants that determine their own objectives and investment mix and therefore the amount of exposure to LDI strategies. Asset managers, meanwhile, advise on how to structure and implement those strategies on behalf of their clients - adjusting them so that they continue to be effective in changing market conditions and meet the objectives of those defined benefit pension plans.

We are not a counterparty for LDI risk mitigation strategies.

What happened between September 23 and 28

As bond yields rise, asset managers like BlackRock periodically ask pension funds to increase the assets in their LDI strategies, if they wish to keep the same exposures.

As UK government bond yields have been rising throughout 2022, asset managers have made such requests dozens of times this year.

But the process takes several days to run, typically more than a week from start to completion. Normally, adjustments to the required assets fluctuate gradually over time, and the amount of excess assets is more than enough to cover requirements based on previously observed market moves. However, due to the extraordinary moves in UK rates and inflation-linked bond markets over the past week, swift action was needed to protect LDI strategies.

What happened from September 23 - up until the point that the Bank of England announced it would buy long-dated UK government bonds to stabilize the market - was that markets were moving so fast that there was simply not enough time to get the required assets into the LDI strategies given how long that process takes.

In these circumstances, BlackRock took steps to protect our clients’ interests – and ultimately the value of the investments that future retirees depend upon. We reduced leverage in a small number of multi-client LDI pooled funds, acting prudently to preserve our clients’ capital in extraordinary market conditions. We sold some assets in a small number of those funds, thereby reducing leverage and their exposures.

Buying and selling of BlackRock’s LDI funds was not halted (or frozen), nor did BlackRock cease trading in UK government bonds.

It is also important to note that while some pension plans have faced calls to increase the assets in their LDI strategies, their solvency was not at issue, given the long-term nature of their liabilities. The rise in bond yields this year – and indeed in the days up until the Bank of England’s intervention – will have in fact enhanced most plans’ funding status.

The Bank of England’s action means the pension and asset management industries can work together to protect the value of pension investments, and to restructure funds to the ultimate benefit of the savers who rely on those funds for their retirement.

BlackRock is committed to helping our clients realize the best outcomes for savers

While pension funds will always want to manage their investments in a liability-aware manner, recent UK market moves may prompt them to consider how their strategies need to evolve.

BlackRock’s purpose is to help more and more people experience financial well-being. We are committed to supporting the UK pensions industry in working through this period of market volatility, to realize the best outcomes for those saving for their retirement.