Don’t panic about your pension
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
The Bank of England (BoE) recently intervened in the UK bond market to try and “save” pension funds from collapse. At Castlegate, we understand that this has caused some to worry about their retirement savings. Below, our financial planning team in Lincoln offers information about what is happening, how it may affect you and why you should stay calm. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Why did the Bank of England intervene?
To understand how the Bank of England’s (BoE’s) recent actions may impact your pension, it is important to explain how pension funds often work. On 23rd September, Chancellor Kwarteng delivered his “Mini-Budget” which introduced a series of tax cuts. The markets largely reacted negatively, with investors worrying how the government could afford to borrow for its spending plans (due to rising interest rates, which is making the cost of public borrowing more expensive). As a result, investors started selling gilts – i.e. bonds issued by the UK government – which drove the price quickly down.
The collapse in these prices rapidly became a big issue for Liability Driven Investment funds, currently valued at about £1.5 trillion. Over £1 trillion of the assets these funds hold are invested in gilts and other bonds. As “leveraged” funds (i.e. funds which use the gilts they buy as collateral to raise cash to buy more bonds), the collapse in the gilt price meant that these funds had to start selling gilts to raise cash to repay the money they borrowed. The BoE recognised that this was becoming a rapid downward spiral, so stepped in to buy £65bn of UK government bonds with a maturity date of 20 years or more. So far, the intervention seems to have worked.
How do the bond collapse and BoE intervention affect me?
It is undeniable that many savers will have seen the value of their pension affected by the recent plunge in gilt prices. So far, at least three UK pension funds have been hit with “margin calls” of as much as £100m (a margin call requires a fund to increase its cash so it can pay liabilities). It is worth noting that a margin call of £100m is not an existential threat to big pension funds, each managing tens of billions of pounds.
Whilst the BoE intervention seems to have brought some calm to markets (yields on 30-year bonds dropped by 100 points shortly after their bond purchase announcement), there may still be choppy waters ahead. The Bank accepts that further interventions may be necessary and all it is trying to do is manage an orderly transition to lower bond prices (not artificially keep them at high prices, indefinitely). Gilts may eventually fall to the low levels seen immediately following the Mini-Budget, which would incur losses on the BoE’s 65bn purcahse of gilts it has promised. In which case, the cost will likely be passed on to taxpayers.
The curious thing about the Bank’s intervention is that it now finds itself pursuing a contradictory strategy. On the one hand, it is raising interest rates (“tightening monetary policy”) to fight rising UK inflation. Yet on the other, it is now buying bonds (i.e. engaging in “loosening” or “quantitative easing”), which encourages banks to lend more and is thus inflationary. As such, the UK’s high inflation problems could persist longer than previously thought.
Why you should stay calm
For those with a final salary (or defined benefit) pension, your scheme should not be at risk from the recent bond market collapse and BoE intervention. First of all, your pension is covered by the Pension Protection Fund (PPF) which guarantees your full pension if your provider fails and you are over your State Pension age. Secondly, the BoE bailout could even put final salary pensions in a stronger position. This is because the pension regulator uses the gilt yield to calculate the value of a scheme’s liabilities. If the yield rises (i.e. bond prices fall), then the value of the liabilities goes down. Therefore, some pension funds could even rise from this stronger.
If you are concerned about your pension funds, then speak to your financial adviser about your long-term investment strategy (which should reflect your risk tolerance, financial goals, time horizon and also funds with strong fundamentals). As a decades-long investment, pensions will naturally go through times of stress and it is important to remain true to your strategy rather than reacting impulsively to present market events.
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
