As the industry's crisis rages a week after the government's "mini" Budget, UK pension schemes are liquidating stocks and bonds to raise cash and demanding rescues from their corporate supporters.
The majority of the UK's 5,200 defined benefit schemes employ derivatives to hedge against changes in interest rates and inflation, which require cash collateral to be provided based on market movements.
The significant drop in the price of 30-year government bonds caused by last week's tax cut announcement resulted in record margin calls or requests for additional cash.
Pension funds liquidated assets, notably government bonds, or gilts, to raise capital, causing prices to fall even lower. The Bank of England intervened on Wednesday to buy gilts, stabilizing the market, while pension funds continue to sell assets to satisfy cash calls.
"There's a lot of anguish out there, a lot of forced selling," Jupiter fund manager Ariel Bezalel said. "People who get margin called have to sell what they can rather than what they want to."
He said the Bank of England's involvement had helped to lower yields on longer-dated bonds, but those other assets, such as corporate bonds, were still "under pressure" because pension funds were "forced to liquidate paper." "We're seeing extremely good investment grade paper come up for grabs... companies like Heathrow, John Lewis, Gatwick, BT — great fundamentals — to raise funds," he continued.
According to an Ice Data Services index, high-grade corporate bonds denominated in sterling have come under heavy selling pressure, with yields rising 1 percentage point to 6.58 percent since the UK fiscal package was announced. Yields have risen 1.63 percentage points this month, the largest monthly increase on record.
Union Investment's head of fixed income fund management, Christian Kopf, said the €416 billion asset manager was able to buy sterling-denominated debt, such as Telefónica bonds, "on the cheap." The Telefónica debt matures at the end of this year, indicating that it is very low risk, but it was priced at a discount due to "panic selling by [UK] pension funds," he explained.
"Some individuals lost money, but we made money," Kopf continued.
"There has been forced selling of everything — equities as well as bonds," said Ross Mitchinson, co-chief executive of UK broker Numis. This week, the UK's domestically focused FTSE 250 fell more than 5%.
In a bid for safety, some managers of so-called liability-driven investing methods are demanding more capital to support the same derivatives position. Legal and General Investment Management, BlackRock, and Insight Investment are among the largest managers.
To pay the collateral calls, several pension plans have turned to the companies that back their programs for cash. According to a person familiar with the situation, outsourcing firm Serco provided £60 million in response to a request from pension trustees, a highly rare step for a well-funded corporate scheme. Sky News initially reported the move.
Chemring's finance director, Andrew Lewis, claimed the company's pension fund sold its entire stocks holding three weeks ago in anticipation of disaster. "We saw gilt yields rise... and you never want to be compelled to sell a liquid asset at a low price." We sold our whole stock position because we anticipated margin calls on the LDI."
While some schemes continue to raise cash to finance their derivatives holdings, others have had their positions canceled by LDI managers such as BlackRock, leaving them vulnerable to additional rate and inflation movements.
"There are undoubtedly schemes that were forced out of the game," Natalie Winterfrost, a professional trustee at Law Debenture, said. A significant number of schemes will have gone unprotected, with much more completely unhedged. If gilt yields continue to decline, their funding positions will deteriorate."
"There could be many hundreds of schemes that have had their hedges lowered or deleted," said Simeon Willis, partner at XPS Pensions Group. This means that their funding positions are now significantly more fragile than they were a week ago."
Although pension funds are still scrambling to respond to the extraordinary market conditions, the situation is calmer than it was before the Bank of England intervened in the market this week.
Many are concerned about what will happen after the central bank's bond-buying binge, which is set to cease on October 14.
"We as a firm continue to be worried that as the clock ticks down to the end of the BoE committed intervention we could see a replay of events and are determined to try to make sure that the chaos that ensued at the beginning of this week is not repeated," said David Fogarty of Dalriada, a firm of professional trustees.