Can Legal & General escape the turmoil that brought the bond markets close to collapse? Asset manager enthusiastically stopped liability-driven investments
Test: L&G boss Nigel Wilson has previously received praise for his work
Just under a year ago, Legal & General Investment Management celebrated a milestone birthday.
It had been 20 years since it began its involvement in an innovative strategy for its pension fund clients. Britain’s largest asset manager enthusiastically endorsed the strategy, boasting in a note last November that it should “help trustees and sponsors sleep better at night.”
So what was the name of this miraculous solution? Liability-driven investment, or LDI, an acronym that few had heard of until a few weeks ago. Now it is synonymous with a near collapse after a bond market sell-off in the wake of former Chancellor Kwasi Kwarteng’s ill-fated mini-Budget.
Legal & General Investment Management is part of the broader L&G life insurance group, whose market value has fallen by more than 10 percent since the mini-Budget.
It’s a rare setback for 10-year-old chief executive Sir Nigel Wilson, 65, who has received critical acclaim for his investment in housing and infrastructure in the UK. Astutely, he turned down a job offer from former Prime Minister Liz Truss as Minister of Investment. He may find he has plenty to do in his day job, as LDIs aren’t the only problem that worries investors in the 186-year-old insurance company.
As fears of a recession mount, they are also concerned about the prospects for the tens of billions of pounds of corporate bonds it owns. The group has admitted that the “extraordinary” and “unprecedented” bond market sell-off has “caused challenges” for its LDI clients.
The idea of LDIs, as the company explained in its November 2021 note, was to reduce the risk that final pay plans will not be able to pay out pensions when they are due. L&G has become the largest player in an industry that has grown in size to £1.6 trillion. It has attracted more pension schemes to adopt the strategy by increasingly leveraging – increasing returns, but also risks, by borrowing. In November, L&G had more than 800 LDI customers.
Analysts estimate it managed £400 billion in LDI funds this year, equivalent to 30 percent of its assets under management.
When the UK bond market collapsed, a sales spiral started that prompted the Bank of England to step in with a temporary pledge to buy up to £65bn worth of bonds.
L&G was able to reassure investors this month that the intervention had eased pressure on customers and that, as an intermediary between customers and lenders, its balance sheet was not visible.
Rival Schroders, a smaller player in the LDI market, revealed this week that it took a £20bn hit in assets in the market maelstrom.
But for L&G, LDI assets under management are likely to have taken a hit at £40 billion, according to an industry analyst.
He said it would have little direct impact on group profits. But what markets are fearing is an increase in corporate bond spreads – the difference between the rates bondholders can charge for loans to companies and the lower rates on UK benchmark government bonds. An increase in those spreads implies nervousness about the prospects of companies. That could pose problems for L&G, which owns £80 billion in corporate bonds to provide an income stream to pay out annuities to retirees, the analyst said.
“If there are a lot of credit defaults and write-downs, L&G would be negatively affected,” he said. “Nothing has happened yet, but spread widening is seen as a harbinger of downgrades and defaults.”
The analyst said L&G’s bond portfolio had performed “extremely well” due to past tensions. But he added: “I understand the fear that if there is a major global credit event, a recession where companies go under and can’t pay their debt – something unexpected – then L&G would be hit.”
He added that this scenario is not the prevailing view at the moment.
L&G said it had not encountered any problems meeting collateral calls in its annuity portfolio.
Analysts at JPMorgan said in a recent note that the LDI episode had had “more positive than negative consequences” for the sector, as it could encourage companies to transfer their pension funds to life insurers such as L&G.
L&G declined to comment.