Can Legal & General avoid the turmoil that brought bond markets close to crashing?

A little less than a year ago, Legal & General Investment Management celebrated an important anniversary.

It’s been 20 years since he started engaging in innovative strategy for pension fund clients. Britain’s biggest asset manager enthusiastically plugged the strategy, boasting in a note last November that it “should help trustees and sponsors sleep better at night”.

So what was the name of this miraculous solution? Liability Oriented Investment, or LDI, is an acronym few people have heard of until a few weeks ago. It is now synonymous with a near-crash following the sell-off in the bond market following former Chancellor Kwasi Kwarteng’s ill-fated mini-budget.

Legal & General Investment Management is part of the wider L&G life insurance group, which saw its market value fall by more than 10 per cent after the mini-budget.

It is a rare setback for Sir Nigel Wilson, 65, chief executive for a decade who has won praise for investing in Britain’s housing and infrastructure. Astutely, he turned down former prime minister Liz Truss’ offer of a job as investment minister. He may find he has plenty to do in his day job, as LDI isn’t the only issue worrying investors in the 186-year-old insurance company.

As fears of a recession grow, so do the prospects for tens of billions of pounds worth of corporate bonds. The group admitted the “extraordinary” and “unprecedented” sell-off in the bond market had “caused challenges” for its LDI clients.

The idea behind LDI, the firm explained in its November 2021 note, was to reduce the risk that final salary pension schemes would not be able to pay pensions as they come due. L&G has become the biggest player in the industry, which has grown to £1.6 trillion. This has attracted more pension schemes to use this strategy through greater leverage – increasing returns, but also risk, through borrowing. By November, L&G had more than 800 LDI customers.

Analysts estimate it has managed £400bn worth of LDI funds this year, equivalent to 30 per cent of its assets under management.

When the UK bond market collapsed, it set off a spiral of selling, prompting the Bank of England to step in with a temporary promise to buy up to £65bn worth of bonds.

L&G was able to reassure investors this month that the intervention had eased pressure on customers and that, as an intermediary between customers and creditors, its balance sheet had not been exposed.

Rival Schroders, a smaller player in the LDI market, revealed this week that it had lost £20bn of assets in the market maelstrom.

But for L&G, according to one analyst who covers the sector, its LDI assets under management are likely to take a £40bn hit.

He said it would have little impact on the group’s bottom line. But what markets fear is a rise in corporate bond spreads – the difference between the rates bondholders can charge to lend to firms, compared with lower rates on benchmark UK government bonds. The widening of these spreads signifies nervousness about the companies’ prospects. That could spell trouble for L&G, which holds £80bn of corporate bonds, to ensure an income stream to pay pensioners, the analyst said.

“If there are a lot of defaults and downgrades in the credit market, that will have a negative impact on L&G,” he said. “So far nothing has happened, but widening spreads are seen as a harbinger of downgrades and defaults.”

The analyst said L&G’s bond portfolio had performed “extremely well” through the previous stresses. But he added: “I understand the concern that if there is a major global credit event, a recession where corporations go under and cannot pay their debts – something unexpected – then L&G will be affected.”

He added that this scenario is not currently the mainstream view.

L&G said it had not experienced any difficulty meeting “collateral calls” on its annuity portfolio.

Analysts at JPMorgan said in a recent note that the LDI episode had “more positive than negative implications” for the sector as it could prompt firms to shift their pension funds to life insurers such as L&G.

L&G declined to comment.