The impact of September’s mini-budget on pensions
In the latest issue of Pensions News, Chair of the Trustee Board Steve Delo gave an overview of the effects of that September’s mini-budget had on the Fund. Here, we look in more depth at why the investment markets reacted dramatically to the mini-budget, why this affected pensions in UK, and what impact that volatility had on the Fund.
Overview
In September 2022, the then-Chancellor Kwasi Kwarteng announced a mini-budget that led to significant turbulence in investment markets.
Not only did the value of the pound fall, but borrowing – including Government borrowing in the form of gilts – also became more expensive. This had an impact on pension funds around the UK.
Sharp rise in cost of Government borrowing
DB pension schemes invest in gilts as they usually offer stable returns – or yields. They’re essentially IOUs from the Government, which sells them so it can raise money for public spending or to fund tax cuts. The unfunded tax cuts laid out in the mini-budget spooked the markets because investors lost confidence that the Government would be able to repay them on time. So, they started demanding higher rates of interest, which means investors’ yields went up – it’s a bit like giving the Government a bad credit score and so it becomes more expensive for the Government to borrow.
DB pensions and gilts
Gilts can also be used as part of a pension scheme’s risk-management strategy because they can use them to match changes in the value of their liabilities (the amount of money the scheme needs to pay out in benefits both now and in the future).
Under this strategy (called a Liability Driven Investment – or LDI – strategy), pension funds enter into contracts with financial institutions, typically banks. As the cost of Government borrowing increased, and the value of Government bonds fell, these institutions required extra payments – called a collateral call – from schemes under the terms of the LDI arrangements.
After the mini-budget, the cost of Government borrowing increased quickly and sharply and to an extent that was unprecedented. DB schemes were forced to sell gilts to meet these extra payments, or collateral calls. The more they sold, the more the value of gilts fell. The more the value of gilts fell, the higher the payments that schemes needed to make – and so on. The Bank of England stepped in briefly to buy up large numbers of gilts, which helped to stop their value falling further. In turn, this meant schemes were no longer forced to sell theirs to meet these calls for collateral.
The Fund remains in good health
Like other pension schemes, the Fund had to sell gilts in order to meet collateral calls from financial institutions. While this did cause the value of the Fund’s assets to fall, our investment strategy is designed so that the value of the Fund’s assets broadly mirrors the value of its long-term liabilities.
Because of this strategy, the funding position of the Fund remains relatively unchanged (it’s still fully funded on a low-risk basis), and it also still has enough assets to be able to pay pensions now and all benefits payable in the future.
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