For those hiding under a rock, the LDI crisis arose from a reckless mini-budget - essentially unfunded tax cuts - which spooked investors. Nominal and real rates rose quickly and by a significant amount. This caused a liquidity shock as pension funds scrambled for collateral to feed their liability hedges.
What's that got to do with DC, I hear you say. Plenty, I say…
It's important that alarming headlines about 'pensions' are followed by reassuring messages to members or customers. UK readers involved in a DC scheme will no doubt have been involved in either crafting, issuing or digesting the mantra that the LDI (or gilts) crisis had no impact on their pension scheme. Fair enough - or is it?
The point is NOT that this specific crisis was weathered. The point is whether your scheme has recognised the possibility of highly disruptive events and developed a playbook to deal with it. A crisis at a given time has a low likelihood (potentially very low). However, the likelihood of a crisis, through time, is close if not equal to 100%. In other words, a crisis of some sort is eventually CERTAIN.
Main lessons for DC schemes from the LDI crisis
Indeed, a playbook almost certainly isn't enough. What's needed is the creation of sufficient 'muscle memory' to deal with it.
For us at Avida, that's the main lesson of the LDI crisis. That trustees, scheme executive teams, fund managers and even counterparties hadn't developed the necessary muscle memory. And that's the relevance.
There follow some examples, but firstly, some qualification. Most schemes have a Business Continuity Plan. The scenarios we envisage are much broader than business continuity outages and indeed we think are more likely. Hence worthy of greater focus.
In your DC scheme, how might you deal with the following:
- a liquidity shock (Woodford springs to mind - essentially a 'run' on an illiquid fund)
- fraud (or similar)
- reputational damage (e.g., unintentional holdings, crypto, ESG red flag..)
- significant underperformance versus peers
- miscalculation/misstatement of prices or index or performance
- opportunities to purchase assets at a discount in disrupted markets
- for commercial schemes, a plan to support a struggling scheme (e.g., merger/acquisition)
- an offer for the business
- financial shock for the sponsor/funder
These are just a few possible examples. These types of events could impair the wealth of your members or customers. Others amount to concrete opportunities to improve the outlook, providing a better retirement across your scheme.
But are you truly ready to manage these 'shocks'? It's worth asking the question.
How Avida can help:
Avida has conducted many crisis management exercises across several large pensions institutions, in the UK and Europe.
Avida can help by stress testing your crisis management plan by using our Crisis Management Radar (CRM).
Avida can also help by offering a tailored crisis management training to find your organisation’s strengths and weaknesses and ability to manage risk or take advantage of disruption.