Portfolio Manager, Peter Brooke, shares his latest Macro Perspectives, focusing this week on the vicious circle sparked by Liz Truss’s tax cuts, which put liability-driven investments under pressure – ultimately leading to political change.
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Peter Brooke 00:00
Good day. My name is Peter Brooke, and I'm a Portfolio Manager at the Old Mutual Investment Group. This has Macro Perspective 44 of 2022, and I'm going to return back to talking about the UK. It almost feels like a soap opera. So, think of Isidingo or something like that. And I heard a fascinating sentence. And it was that Liz Truss was taken out by LDI investors. So, remember, I spoke about how strong the bond market is, what LDI is, is actually liability driven investing. And I think most people won't know that much about it. But luckily, we've got a complete expert here. So, Trevor Abromowitz is the Head of our LDI department. And he manages more than 50 billion rand in South Africa, making him one of the two biggest players in the country. So, Trevor, can you just explain very simply, what LDI or liability driven investing is?
Trevor Abromowitz 00:54
Sure. Liability driven investing focuses on an investor's liabilities, whatever they may be, and manages a portfolio so that the assets move very much in line with the liabilities. Defined benefit funds are major users of LDI strategies, and their liabilities are valued using government bonds. And so, the matching asset for these funds is typically government bonds.
Peter Brooke 01:21
And that's exactly why in the UK, it was when the bond yields went up, that these funds came under pressure. And then that started a vicious spiral. So, can you tell us a bit more about what actually happened in the UK market, and why we had such a big sell off in the UK?
Trevor Abromowitz 01:37
Absolutely. So, when the Truss government announced their unfunded tax cuts and their mini budget had caused the UK government bond market to sell off considerably, and one of the significant secondary impact was that UK pension funds needed to post cash collateral in order to meet the calls from the different investment banks that they had transacted with. In order to meet the cash collateral requirements, they had to sell their government bond holdings, or Gilts, in order to meet these collateral calls and ensure that they were trading in line with their various agreements. This exacerbated the problem because they were selling their government bonds at a very weak time of the market when liquidity was extremely low.
Peter Brooke 02:22
So actually, what we got is a vicious circle making things worse. And that's what panicked world markets, the bond markets, and forced a political change. So, do you think the same thing could happen in South Africa?
Trevor Abromowitz 02:35
The South African market is very different to the UK market. We have a much lower number of defined benefit funds in our country with a much lower level of assets under management. We've also got very stringent risk measures that we use across the LDI industry to make sure that our hedging is taught, controlled, and well managed. So, we can get into considerable technical detail. But suffice to say that the South African... our market is in a much better position than our UK counterparts.
Peter Brooke 03:06
And one of the reasons for that is also the funding levels of the South African pension funds are in better shape. And it just highlights that actually, one of the key strengths of South Africa is our financial services industry, and our regulatory environment, which enables us to ride out some of these difficult times better than other places. And I think that's really what I wanted to bring to the fore here, is we've spoken a bit over time as US rates go up and liquidity gets sucked out of the system, we'll start to see different areas fall over. So, for instance, Sri Lanka has gone bankrupt, or we've seen some of those stable coins go under. We're now sort of seeing it moving up into different parts of the world. So, now we've seen a bit of a attack on LDI. And the positions there in the UK. And the truth is, we don't know what comes next. But it is a tricky environment, that as liquidity gets tightened, and as a result of that, we are running with a little bit more cash in our funds, just to have that little bit of buffer in case something goes wrong.
I hope you found this perspective useful. Until next week.