Can Legal & General escape the turmoil that has left bond markets on the brink of collapse? Asset manager enthusiastically plugged into liability-driven investing
Test: L&G boss Nigel Wilson has already won praise for his work
A little less than a year ago, Legal & General Investment Management celebrated a milestone anniversary.
It has been 20 years since it embarked on an innovative strategy for its pension fund clients. Britain’s biggest asset manager has enthusiastically embraced the strategy, boasting in a note last November that it “should help directors and sponsors sleep better at night”.
What was the name of this miraculous solution? Liability Driven Investing, or LDI – an abbreviation few had heard of until a few weeks ago. Today, it is synonymous with a near-collapse after a sell-off in the bond market following former Chancellor Kwasi Kwarteng’s ill-fated mini-budget.
Legal & General Investment Management is part of the L&G life insurance group, whose market value has fallen more than 10% since the mini-budget.
It’s a rare setback for chief executive of ten years, Sir Nigel Wilson, 65, who has won praise for investing in UK housing and infrastructure. Cleverly, he rejected a job offer from former prime minister Liz Truss as investment minister. He may find he has a lot to do in his day job, as LDIs aren’t the only issue worrying investors in the 186-year-old insurance company.
As recession fears grow, they also worry about the prospects for the tens of billions of pounds of corporate bonds he holds. The group admitted that the “extraordinary” and “unprecedented” sell-off in the bond market has “caused challenges” for its LDI clients.
The idea of the LDIs, as the firm explained in its November 2021 note, was to reduce the risk that end-of-career schemes would not be able to pay pensions when they fell due. L&G has become the biggest player in an industry that has reached £1.6trillion. It has attracted more pension plans to use the strategy by increasingly using leverage – increasing returns, but also risk, by borrowing. In November, L&G had more than 800 LDI customers.
Analysts estimate that this year it managed £400bn of LDI funds, or 30% of its assets under management.
When the UK bond market crashed, it created a selling spiral that prompted the Bank of England to step in with a temporary promise to buy up to £65 billion 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 at risk.
Rival Schroders, a smaller player in the LDI market, revealed this week that it had taken £20 billion from the assets of the market’s maelstrom.
But for L&G, its LDI assets under management have likely taken a £40bn hit, according to an analyst covering the sector.
He said it would have little direct impact on the group’s profits. But what markets fear is a rise in corporate bond spreads – the difference between the rates bondholders can charge for corporate loans and the lower rates on government bonds. benchmark British. An increase in these spreads implies nervousness about the prospects of companies. It could spell trouble for L&G, which holds £80bn of corporate bonds to provide a stream of income to pay out pensions to pensioners, the analyst said.
“If there are a lot of defaults and downgrades in the credit market, L&G would be negatively affected,” he said. “Nothing has happened yet, but widening spreads are seen as a precursor to downgrades and defaults.”
The analyst said L&G’s bond portfolio had performed “extremely well” during previous stresses. But he added: ‘I understand the fears that if there is a big global credit event, a recession where companies sink and cannot pay their debt – something unexpected – then L&G would be affected.’
He added that this scenario is not currently the prevailing opinion.
L&G said it had encountered no difficulty meeting “collateral calls” in its annuity portfolio.
JPMorgan analysts said in a recent note that the LDI episode had “more positive than negative consequences” for the sector, as it could prompt companies to offload their pension funds to life insurers such as L&G.
L&G declined to comment.