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How a decade of low interest rates put pensions at risk - THE TELEGRAPH

NOVEMBER 26, 2022

BY  Simon Foy

Known for its excellent public school system, high salaries and generous pensions, the Canadian province of Ontario is a good place to be a teacher.

But recent events have left the region’s educators questioning where their hard-earned cash is going.

The Ontario Teachers’ Pension Plan (OTPP), one of the largest pension schemes in the world with more than $182bn (£150bn) in assets, this month revealed that it was forced to write off its near-$100m stake in collapsed crypto exchange FTX.

The move came barely a year after OTPP, once heralded as a pensions pioneer, made its first investment in Sam Bankman-Fried’s defunct business. Embarrassingly, it said in September that its investment in FTX had one of the "lowest" risk profiles in the crypto industry.

While the fund said the writedown will only have a “limited impact”, its investment in FTX is nonetheless indicative of how a decade of low interest rates has pushed retirement savings into increasingly risky bets that are now going up in flames.

In the UK, the recent damage to retirees’ savings was done not through such a nakedly risky bet, but via an investment strategy that was deemed by City advisers and regulators to be safe: Liability-driven investments (LDI).

Now, as bond yields rise once again after years of stagnation, will pension funds shun riskier punts for the safe haven of government paper, and if so, could that dampen their appetite to back badly needed infrastructure projects in Britain?

OTPP was not the first pension giant to get burnt by the crypto craze. In August, Canada’s second largest retirement fund Caisse de dépôt et placement du Québec (CDPQ) wrote down about $150m of its investments in crypto lending company Celsius after it filed for bankruptcy.

US public pension funds have largely shunned direct crypto investments but there are growing calls for them to be banned from backing anything crypto-related.

Letitia James, New York’s Attorney General, last week urged Congress to bring forward legislation that would prohibit retirement funds from backing cryptocurrencies, digital coins, digital tokens, and other digital assets.

She said: “Investing Americans’ hard-earned retirement funds in crashing cryptocurrencies could wipe away a lifetime’s worth of hard work.

“Over and over again, we have seen the dangers and pitfalls of cryptocurrencies and the wild swings in these funds. Hard working Americans should not have to worry about their retirement savings being wiped out due to risky bets on unstable assets like cryptocurrencies.”

The growing appetite of British pension funds to take risk was laid bare following Liz Truss’ mini-Budget, when it was revealed that the LDI schemes they employed were highly leveraged.

As gilt yields rose, pension fund managers were issued with “margin calls” to post collateral on LDIs to honour their leveraged bets on gilts, forcing them to sell more bonds.

The Bank of England stepped in amid warnings of a “material risk to UK financial stability” in the wake of a run on pension schemes likened to that of the crisis facing Northern Rock before its collapse in 2008.

On November 24, MPs were told that the market chaos contributed to driving down the value of retirement schemes by as much as £500bn, while one bond market veteran said the “use of derivatives to hedge liabilities is almost certainly illegal”.

John Ralfe, an independent pensions expert, says the fact that funds were forced to go “whinging” to the Bank for a bailout shows that leverage should be banned for pension schemes.

He adds: “To a greater or lesser extent, UK pensions have matched the liabilities side of their balance sheets through leveraged LDIs, which allowed them to continue backing risky assets on the other side, such as hedge funds and property.

“Lots of schemes are attracted to assets like private equity and hedge funds because they’re illiquid and appear to be less volatile as they don’t have the same price movement as equities.”

Pension funds using leverage is not solely a UK phenomenon. Last year, the board of the $495bn California Public Employees’ Retirement System (Calpers), the biggest scheme in the US, voted to use borrowed money and invest in more alternative assets for the first time.

Over the last decade, funds have been forced to go in search of yield in riskier assets as government bonds produced weak returns.

For example, BT Pension Scheme, the UK’s largest private sector retirement scheme with £47bn under management, has a quarter of its funds invested in “growth assets” and property, with another 27.5pc tied up in private credit.

As interest rates rise and funds look to de-risk their portfolios, Ralfe says: “We are going to see a shift and see pension schemes moving out of illiquid assets and moving back into things that are more liquid, properly and easily priced with a degree of transparency.”

Yet a move away from illiquid assets could come at an inopportune time for the Government. British pension funds have historically shied away from backing UK infrastructure projects, in part due to the smaller scale of the schemes compared to their international counterparts.

Other countries have been more active in encouraging their retirement schemes to support the wider economy by loosening investment limits.

Croatia has allowed mandatory pension funds to invest in infrastructure projects directly, while Romania has allowed its funds to invest 15pc of their assets in infrastructure.

Meanwhile Switzerland has created a separate investment category for infrastructure with a 10pc limit, separated from the 15pc limit for other alternative investments to allow pension funds to expand their exposure to long-term projects.

In the UK, the Government is trying to encourage more British institutional investment in the country's infrastructure by easing restrictions around Solvency 2 rules, which requires insurers to hold vast sums of cash on their balance sheets and dictates where they can invest.

Ralfe says a shift away from longer-term assets “will work against the Government’s aim of getting DC pension funds to invest in illiquid assets like infrastructure”.

Ontario’s teachers’ savings were invested in FTX through the fund’s “Teachers’ Venture Growth” (TVG) platform. TVG, which directly backs “innovative, late-stage companies that are using technology to shape a better future”, acts as a prime example of just how much risk pension funds have been willing to take in recent years.

Following FTX’s demise, OTPP said: “Naturally, not all of the investments in this early-stage asset class perform to expectations, however, since inception, TVG has delivered solidly on intended objectives.”

The Canadian province, known for its sprawling forests, picturesque provincial parks and Great Lakes, is an ideal location to live out the latter years of life.

Ontario’s teachers will be hoping that the fund managing their savings will make their retirement as comfortable as possible and avoid taking bets on companies that, by OTPP’s own admission, now looks like a “potential fraud”.


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