Yahoo Finance The bond chaos has hit L&G hard – but here's why investors should keep faith
Legal & General has been having a tough time of it since Kwasi Kwarteng’s disastrous mini‑Budget: its shares have lost about a 10th of their value in those four weeks, compared with (for example) 5.6pc for Direct Line, a more bread‑and‑butter insurer, and 4.3pc for the FTSE 100.
It’s not hard to see the reason: L&G is involved in the “liability‑driven investments” that caused such trouble that the Bank of England had to step in with a multi-billion pound rescue package. But this apparent weakness in L&G’s business model may, perversely and we might say undeservedly, turn into a strength.
The mechanics of LDI schemes are hideously complex and this column has no wish to delve into them. Let’s just say that they offer – or at least were supposed to offer – a way to reduce risk for final salary pension schemes in the private sector, which manage large sums of money but have the responsibility to use that money to generate a secure, index‑linked income for life for all their members in retirement.
As we have seen, what LDI arrangements actually did was increase risk for pension schemes to the point that some were on the brink of collapse.
Final salary schemes may therefore think twice about using them in future and seek alternative ways to cut risk. One is to buy “bulk annuities”: hand a large lump sum to an insurer in return for which the insurer, not the pension scheme, has the duty to pay each pensioner the retirement income they are entitled to until they die.
While LDI schemes were aptly described in these pages as “too clever by half”, bulk annuities strike this column as an uncomplicated way to transfer the pension fund’s risk to an insurer permanently and safely, with none of the scope to blow up in unusual circumstances that turned out to lurk in LDI arrangements.
And it just so happens that one of the biggest players in the bulk annuity market is the same Legal & General.
In a note on the effects of the mini‑Budget chaos on life insurers, UBS, the investment bank, said “margin calls on LDI mandates” – the cause of all the trouble, as pension funds forced to find cash in a hurry panic‑sold gilts – “may also make these solutions [LDI] less popular” in future.
It added: “We also see a potential increase in pension de‑risking solutions/bulk annuity volumes as a result of the crisis.”
L&G is already one of the leaders in bulk annuities so we could expect it to be one of the principal beneficiaries of such a change in behaviour on the part of pension funds.
UBS said it expected record volumes of bulk annuity business across the market this year. It put the size of the market in Britain at £30bn‑£40bn in 2022 and said it expected L&G to take about 25pc of it. “L&G’s bulk annuity business has tailwinds,” the bank said.
While L&G’s reputation could suffer some damage as a result of its involvement in the LDI market, its own finances should not have been affected by the chaos.
It confirmed that it acted as an agent between clients and market counterparties on its LDI business and therefore had no balance sheet exposure from the emergency action that pension funds had had to take in relation to their LDI investments.
More broadly it said recent market volatility was manageable, with reported solvency levels at record high levels at the end of September of 235pc‑240pc, driven by the increase in interest rates.
While the positive case for L&G was strong – a well-defined model, good growth in its mutually reinforcing businesses, a healthy and growing dividend – there was always a counter‑argument, which we could sum up in the aphorism that you should never invest in anything you don’t understand.
Questor doubts that more than a handful of especially diligent professional analysts and investors truly understood how some of L&G’s more complex investment strategies worked, no matter if it was not directly exposed to the risks now apparent.
Nonetheless, it seems to have passed this recent test and we should also acknowledge that much of its business, such as asset management and bulk annuities, is straightforward enough. It’s a close call, but on balance we’ll hold for the dividend.
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