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Some of Britain’s biggest corporate pension schemes have poured billions into the same complex financial products that prompted a bailout by the Bank of England, it can be revealed.
An investigation by The Mail on Sunday found schemes run by oil giant BP, aerospace manufacturer Rolls-Royce and Royal Mail have huge liability driven investments (LDIs) which are designed to protect against interest rate and inflation spikes.
The widespread use of LDIs by company pension funds running final salary schemes sparked the recent sell-off in Government bonds, known as gilts.
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Precarious: BP, Rolls-Royce and Royal Mail have huge liability driven investments which are designed to protect against interest rate and inflation spikes
Bank chief Andrew Bailey was forced to step in with a £65billion support package.
The full extent of the reliance on LDIs by major company schemes is only now beginning to emerge.
BP documents show almost £30billion is invested under its pension fund’s LDI strategy.
The energy conglomerate’s scheme pays pensions based on the final salaries of its 60,000 members. It has assets of £47billion – making it one of the biggest in the country.
The scheme is in surplus, meaning it currently has more assets than it needs to cover current and future payments to members. Experts say it has been managed prudently after it closed to new members more than a decade ago.
Other giant schemes relying on LDIs include the Rolls-Royce defined benefit scheme, which has around 38,000 members. It includes an LDI portfolio of nearly £9billion.
Royal Mail, with 125,000 members, has built up an LDI portfolio worth £8 billion. British Airways’ pension scheme also has some limited exposure.
The use of LDIs has grown dramatically in recent years as companies closed their final salary schemes to new members and moved some of their pension liabilities off their balance sheets. LDI funds invest heavily in supposedly ‘safe’ gilts but they also use leverage to enhance returns. This benefits pension funds when interest rates are low and stable but goes into reverse when they rise suddenly.
This happened in the wake of former Chancellor Kwasi Kwarteng’s mini-Budget three weeks ago. That caused a scramble by investors to sell more gilts to meet more ‘margin’ calls from other investors, leading to a potential ‘doom-loop’. The bank’s intervention, which ended on Friday after it bought almost £20billion of gilts, has so far prevented the contagion spreading.
Pension fund Legal & General has already emerged as one of the biggest providers of LDIs in the UK alongside BlackRock and Insight Investments.
Former Bank of England chief Mervyn King this weekend said funds had been ‘caught out’. He warned there will be ‘quite a debate as to why the pension funds were allowed to borrow’ under such complex arrangements.
There is no suggestion that any of the funds mentioned above are at risk. But experts say some of Britain’s 5,200 final salary schemes may need to sell assets, such as equities, to deal with the fall-out. The corporate schemes named here today have all been explicit about their use of LDIs in their company documents. But The Mail on Sunday has been told that many other companies have significant LDI investments – including some that were approached this week but declined to confirm or give details.
There is no obligation for funds to publicly reveal the extent of their LDI links. That could become an increasing issue in the coming weeks, particularly if problems at smaller or more vulnerable funds emerge.
Iain Clacher, Professor of Pensions & Finance at Leeds University Business School, said: ‘One of the major problems here is that the size of LDI exposure is not very visible. There are also huge variations in exposure to LDIs, and this isn’t visible either.
‘This lack of disclosure and market oversight is a significant failing and it comes back to the Pensions Regulator.’
A Rolls-Royce spokesman said last night: ‘The Rolls-Royce UK Pension Fund is one of the few in the FTSE 100 which is in significant surplus. The current market volatility is not impacting our defined benefit pension scheme.
‘The fact that the scheme is not affected is testament to the long-term approach that has been taken to pension risk management over many years.’
BP declined to comment beyond the information already provided.
Royal Mail said its pension plan uses LDI funds but that it was ‘not affected as other UK schemes were’. It added: ‘The Royal Mail Pension Plan regularly buys and sells assets. It is not a forced seller of any assets. Collateral needs were met.’
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