New adventure - first week thoughts

So I am a few days into my new adventure. There are two main topics I want to talk about.

Firstly my message about starting this new adventure seemed to receive loads of comments (relative to what I am used to which is a low bar) which has been really fun. Thank you to everyone for your kind messages. I have tried to reply to all comments but apologies if I have missed any. The one thing I will say though is this social media business takes a lot of commitment so much kudos to those who are able to do it so well!

Secondly, LDI and the events of last week. My intention was to write a post on what LDI is and what has happened but from a few days of trawling the news/social media I think that has been done (with a few nuances that people probably are too exhausted to be bothered about).

For those who haven’t been reading everything, if there was one thing to read to get up to speed it is Dan Mikulskis blog which brings together the history and last week’s events quite nicely (it is such a good summary the FT picked it up).

Instead of rehashing what has already been written this, these are my initial top 5 questions/things I am “interested” in (some more words behind each question lower down):

1.????When/if did the market moves become self-fulfilling?

2.????LDI collateral pool “rules” and how are these designed going forwards?

3.????What will happen to the LDI market and the product/strategy offerings?

4.????A well considered discussion on “leverage” is required

5.????What will happen to the rest of the pension schemes investment strategy?

A bit more explanation on each below:

When/if did the market moves become self-fulfilling?

People had prepared for rising rates and were not worried about that per se (listen to the investment uncut podcast from June where Steve Hodder discussed this). So is the issue the speed of rising rates in the last week? If so, it would be interesting to see at what point mechanistic closing out of positions (for example by pooled LDI with specific rules) became the driving force of rate moves. It is important to understand this as it helps understand whether it can happen again.

LDI collateral pool “rules” and how are these designed going forwards?

It is important to differentiate between collateral/margin calls and a “collateral pool”. The former happens every day and has done as long as I can remember – it is how counterparty risk is managed. Because this process can only be fulfilled with cash or gilts, LDI mandates need to hold a “collateral pool” ready to meet these daily demands. A key question in LDI is how big should that pool be and when should it be topped up? Both of these questions are entirely a function of the asset management product being used and its associated “rules”. How much of a role did the rules themselves have to play in the market movements? How do you design these rules going forwards? How do you calibrate them?

?What will happen to the LDI market and the product/strategy offerings?

As most people are saying, I would be very surprised if changes were not made. It would also not surprise me if as a result of the changes required some providers pulled out of the market. But as most commentators say, LDI has a place in investment strategies (even more so with higher rates) and so what the remaining strategies look like will be important. There are lazy answers here but it is a time for the industry to innovate to provide the best result for clients.

A well considered discussion on leverage is required

Most articles have featured the term leverage as the cause or the problem. Some articles have suggested regulation to control leverage. I agree this needs to be investigated but it needs to come from a considered perspective. The risk of “leverage” (and I think generally this is code word for derivatives) is different with different tools and different applications – for example the experience of Pooled LDI I expect to have been very different to Segregated LDI. The experience of currency hedged equity funds in recent months is different again. The reason I think this is important is that the automatic presumption is that leverage is bad. This is not always the case. Rather than take over this post I might write something separate on this.

?What will happen to the rest of the pension schemes investment strategy?

As last week showed LDI pervades the entire strategy. Most people have raised questions on this, the most pertinent for me are: what is the new view on illiquid assets? How liquid does something have to be to qualify for a collateral waterfall (as someone who did fluid mechanics years ago a steady state waterfall has the same flow rate at the top and the bottom and so the liquidity profile of all assets in a waterfall should be the same)? Do synthetic growth assets become important as a more capital efficient tool?

There is plenty more stuff in my head about this but would be interested in people’s views, comments and challenges.