What Does the LDI Crisis Mean for UK DC Savers?

25 October 2022

3 min read

David Hutchins, FIA| Portfolio Manager—Multi-Asset Solutions

Henry Smith, CFA| Investment Strategist—Multi-Asset Solutions

The recent crisis in UK bond markets stemming from the government’s “mini” budget has shone a spotlight on defined benefit (DB) pensions and their liability-driven investing (LDI) strategies. But the investment implications extend across the whole UK savings industry and highlight a range of issues for defined contribution (DC) members too.

For the UK’s DC savers, this year’s stock market falls have been exacerbated by the recent sell-off in UK bonds. In a year when both global equity and fixed-income markets have delivered negative returns, even DC members invested in well-diversified strategies have mostly suffered capital losses. Many DC savers in their late fifties and early sixties will probably be reappraising their retirement planning in the light of cost-of-living problems. But amid the savings gloom there are some positives for DC savers.

Annuitization Is Now a Realistic Retirement Strategy

Older members looking to take cash will be worse off than in 2021. But some older DC savers now have the opportunity to lock in much higher levels of retirement income via annuitization than were possible only a short time ago. This advantage applies to savers who invested in a sufficiently diversified asset mix that kept their retirement options open, rather than a portfolio limited to UK government bonds.

Older Savers Can Now Achieve a Higher Annuity Income in Retirement

Rising Annuity Rates Typically More than Offset Falls in DC Savings

Past performance does not guarantee future results.
This chart illustrates the capital growth of £100 invested on March 31, 2015 in the AllianceBernstein 2020–2022 Retirement Strategy Target Date Fund and is net of fees. The conversion to an annuity is by reference to an annuity purchased with the capital available for such an investor, scaled to £100 per month as of December 31, 2015. The reference annuity is for a healthy, non-smoking 65-year-old living in Chelmsford, UK, is level in payment and has an attaching 50% reversionary annuity on the death of the policyholder. Annuity rates are the observed best-in-market rates by AB at the end of each month for a purchase amount of £20,000.
As of September 30, 2022
Source: AllianceBernstein (AB)

Consider the case of a notional 65-year-old saver. In the Display above, we compare the capital value of the saver’s DC savings pot (yellow capital line) with the income available from that portfolio if converted at prevailing annuity rates (blue income line). This year’s market falls have reduced the capital value (by roughly 10% to 30 September based on a representative target date fund’s total return). But annuity rates for this age group rose by almost 50% in the first nine months of 2022. On that basis, a savings pot worth only 90% of the 2021 value could buy a third more income than last year.

This is possible because rising bond yields have triggered a repricing of annuity rates and transformed annuitization from a largely obsolete retirement strategy to a potentially attractive one. How long can this last? We think UK government bond yields will eventually fall back from crisis levels and annuity rates will fall with them—but the era of ultra-low interest rates that made annuities chronically unattractive is over. This is positive for future DC retirees, who will genuinely have more freedom and choice.

Younger Savers: Lower Valuations Now Mean Higher Returns Later

Younger DC savers will also—ultimately—stand to benefit from lower capital values and higher yields at the start of their careers. Lower valuations today increase the probability of higher returns in subsequent years.

To be sure, early capital losses feel painful and down markets can be discouraging. But younger savers have many investing years ahead and will likely benefit from starting to put their money to work when valuations have fallen to lower levels, setting the stage for greater appreciation potential over time. For DC savers starting to transition from growth assets to bonds, the same point applies: UK fixed-income valuations are more attractive now and switching into them will generate greater income than before.

Bond Market Crisis Refocuses Savings Industry Thinking

The LDI crisis has added urgency to industry debates about key issues such as asset allocation and risk profiles. We believe that, in particular, it will lead to a better understanding of the need for real assets in inflationary times and the attractions of private assets to boost longer-term returns. While UK regulation will shape the outcomes from those debates, we believe DC savers as a whole should benefit from product providers’ heightened awareness of these strategic issues.

DC savers are contending with a challenging economic and market environment today. But the LDI crisis has highlighted key challenges and helped show some ways forward for DC retirees and for DC product providers.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

David Hutchins, FIA

David Hutchins is a Senior Vice President and Head of AB's Multi-Asset Solutions business in EMEA. He is responsible for the development and management of multi-asset portfolios for a range of clients. Hutchins joined the firm in 2008 after spending two years at UBS Investment Bank, where he was responsible for devising and delivering innovative capital markets risk-management solutions for pension schemes. Prior to that, he spent 13 years at Mercer, where he served as a European principal and scheme actuary, providing trustee and corporate advice to a range of UK pension funds and their sponsors. Hutchins holds a BSc in mathematics and a PGCE from the University of Bristol. He has chaired the Investment Management Association's Defined Contribution Committee and formerly chaired the defined contribution industry working group for the UK government's "defined ambition" project. Hutchins is a Fellow of the Institute and Faculty of Actuaries. Location: London

Henry Smith, CFA

Henry Smith is a Vice President and Investment Strategist on AB’s Multi-Asset Solutions team. He is responsible for the product strategy and communication of AB’s UK defined contribution, custom multi-asset and sustainable multi-asset solutions. Smith joined the firm in 2019, following more than two years at Lane Clark & Peacock, where he provided investment, research and governance advice to a range of UK defined contribution pension schemes. Before that, he worked at Capita Employee Solutions, where he advised both UK defined contribution and defined benefit pension schemes. Smith holds a BSc in financial economics from the University of Essex and is a CFA charterholder. Location: London

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