As the Bank of England scrambled to calm markets with a surprise round of quantitative easing (QE), or bond-buying, on Wednesday 28 September, rumours flew around social media that the move had been triggered by pension funds.
The theory makes sense – pension funds are, after all, holders of government debt, which has been falling in value since the disastrous mini-Budget was announced – but economists’ assertions that they are struggling to meet margin calls were more worrying. Here’s a brief explanation of what last week’s movements could mean for your pension.
What is a margin call?
The biggest UK pension funds manage tens of billions of pounds each, and to do so in a stable manner they don’t just buy investments, they also buy other products that help them manage the risk that those investments will change in value. The products are often leveraged (paid for using debt), which allows the fund to cover more risk for less money. However, if the investments’ value changes quickly and significantly (in response to, for example, a government unveiling the biggest tax cuts for half a century while inflation is at 9.9 per cent), the debt also becomes a risk to the bank or other financial institution that issued it, which will issue a “margin call”: it will ask the pension fund to increase the money it has available to pay it, or margin, in its account. On Tuesday night it was reported that at least three UK pension funds had been hit with margin calls of as much as £100m.
Why did the Bank of England react as it did?
For pension funds, this situation represents a liquidity problem: to get the cash needed to meet a margin call of this size, many need to sell assets – and one of the assets they hold a lot of, because it is historically fairly low-risk, is long-dated government bonds (gilts). The price of these was already low and volatile, however, and a sell-off by massive investors such as pension funds would cause prices to drop even further.
The Bank of England’s announcement made particular reference to “long-dated UK government debt”, and nodded to pension funds when it warned that “were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability”. It was also reported that Bank officials were concerned they were witnessing the early phases of a “dynamic run”, the scenario which led to the collapse of Northern Rock in 2008. The Bank’s solution was to step in to buy long-dated gilts, which it hoped would stabilise prices.
The move seems to have worked: yields (which move in the opposite direction to prices) on 30-year gilts dropped by almost 100 basis points – one percentage point – by mid-afternoon, while ten-year yields had dropped by 50 basis points. This leaves the Bank of England in the peculiar position that, on the one hand, it is raising interest rates – a disinflationary approach known as “tightening” monetary policy – while on the other it is buying bonds, an inflationary move known as “loosening”.
How safe is my pension?
Even a £100m margin call is not an existential threat to a large pension fund, and in the event that a fund becomes insolvent, up to £85,000 per person per institution is protected by the Financial Services Compensation Scheme (FSCS) (although this does, naturally, have to be covered with even more government borrowing, as in 2008, when the Bank of England provided a loan for the FSCS to help Bradford & Bingley customers).
If you’re in a final salary scheme and the company you are working for goes out of business, your pension goes into the Pension Protection Fund. In that case, if you’re over state pension age, you receive your full pension (if you’re under, it’s 90 per cent).
The bad news is that those who are closer to retirement are more likely to have been affected by events last week, because investors tend to move these people’s money into to lower-risk assets – such as long-dated government bonds – as they get nearer to retirement. So although pension funds are at little risk, people’s pension pots may look a little leaner for the time being.
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, points out that pensions are a “long-term investment, and they will at times go through periods of severe stress”. “If you still have years to go before you retire then you will have time for the market to recover. Making knee-jerk reactions like changing your investment strategy increases the likelihood of locking in losses, which makes it harder to recover.”
[See also: The Bank of England is right to hold its nerve]
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