Can someone explain in laymans terms what is happening with the BOE/pension funds on Friday?

[Silverin]

There seems to be a lot of panicked talk in the financial media about pension funds potentially collapsing and the BOE needing to step in to help them but this support being stopped on Friday.

As a layperson, I would like to understand what is going on - what are gilts, what did the BOE do/not do and what are the risks to pension funds that could cause a collapse on Friday?

[edwinbear]

What I understand, re the offer not being taken up, is that whilst the BoE have held a daily auction to buy up gilts, they have rejected a lot of the offers as they've said they won't buy them 'at any price'. Which is understandable, given the government are indemnifying them from any losses. So the message is (I think), we stand by, ready to support - but at sensible prices, don't take advantage.

[edwinbear]

www.reuters.com/markets/rates-bonds/bank-england-rejects-all-gilts-offered-market-backstop-operation-2022-10-04/

Article here, which means a reserve price.

[StatisticallyChallenged]

There's two elements - the gilt buying and the repo operations. You're right re the gilt buying, looks like the sellers and the bank have different views on price. The sellers are currently the equivalent of the awkward house seller who refuses to accept what their house is worth...

Of course BoE might be lowballing...

[XingMing]

Just chipping in to add my congratulations for those who have explained very complex topics so lucidly, and to ask @MNHQ to add this very useful thread to the Classics section.

I think it was @BernadetteRostankowskiWolowitz who asked what to do about her DB pension fund as her employer was looking rocky. This happened to me about 30 years ago. My employer went bankrupt over a Bank Holiday weekend. The people who ended up looking after the orderly winding up process worked with the insolvency practicioners to salvage the pension fund and did so by buying annuities for members. My pot was only worth about £18k, but it was rolled into an annuity with an insurance company and the trustees achieved a guarantee that interest equivalent to 8% pa would be added until pension started paying out. In retrospect everyone was phenonenally fortunate because since the GFC there have been few low-risk investments achieving 8% returns simply because interest rates have been so low. Now I get a small pension monthly, and my state pension has kicked in, plus I still work PT.

If you are confident of making investment decisions, and most people arent' really, then a SIPP is probably a sensible avenue to consider.

[edwinbear]

I agree - it's very hard to place a true value on them at the moment with such huge volatility, but I think from the BoE's perspective, it's a buyers market right now. Hence them coming out and reminding the pension funds they're not in a great negotiating position right now. As a PP said - it's basically a massive game of chicken, albeit with hefty stakes.

[StatisticallyChallenged]

@Faciadipasta

My dad is meant to be retiring at the end of the year. I'm really worried what this all means for his pot. Timing really couldn't be worse

Do you know what sort of pension he has? DB/DC, if DB what is the scheme like, if DC what is he invested in, etc

[Pinkcadillac]

This is a good Twitter thread by Ed Conway twitter.com/EdConwaySky/status/1580152813203914753

[SerendipityJane]

@StatisticallyChallenged

They can, but it's much harder to do retrospectively - which is what they would need to do. They would effectively need to invalidate employment contracts going back as far as the oldest pensioner. And even if they somehow managed that they'd have to deal with such massive walkouts from every corner of the public sector that the country would grind to a screeching halt

And I'm not a fucking idiot, thanks 🙄I just don't think scaremongering helps.

Not hard to make a law retrospective. Ask the workfare victims. And with the cost of living crisis, inflation and pisspoor pay rises, this government has effectively robbed everyone of hundreds if not thousands of pounds a year.

[stayathomegardener]

We are in the process of buying out our SIPP but what to do then? 25% tax free is easy but where to invest the three quarters remaining?

Any good podcast recommendations would be gratefully received.

[Faciadipasta]

@StatisticallyChallenged he's self employed so it's a private pension. Must be a defined contribution I guess and being so close to cashing out I'd wager that it's almost all in government debt. He won't know. He knows absolutely NOTHING about finance. I'm genuinely scared for him

[StatisticallyChallenged]

@Faciadipasta

@StatisticallyChallenged he's self employed so it's a private pension. Must be a defined contribution I guess and being so close to cashing out I'd wager that it's almost all in government debt. He won't know. He knows absolutely NOTHING about finance. I'm genuinely scared for him

If he's in some sort of lifestyling fund (which was often the default for simple pensions) he may actually have moved out of gilts either wholly or largely if he has 1 year to go until the retirement date his pension company had, some were/are super cautious.

You really won't know until you find out what he's invested in.

[User123456713]

@Faciadipasta Your father should be able to set up a log in so he can see the fund value and get a retirement pack with a predicted annual pension with an annuity (which he doesn't have to take)

Pension Funds don't invest in one thing, they'll have a very broad range of bonds, gilts, shares, commercial property, even gold and they will also have a global element too.

My SIPP pension has lost about 8% recently, to put that in perspective, after the GFC it lost over 20% but within 12 months made it all back up again.

[StatisticallyChallenged]

@Pinkcadillac

Would you increase your pension contributions if you were 52 and have only started a pension 7 years ago? My employer contributes 20%. My contributions currently do not match that.

I'm paying into an ISA and overpaying my mortgage (current interest rate is 4% - just fixed last week)

I qualify for state pension as was self employed for 20 years (no private pension though during this time).

There's no simple answer to this, but a few things to consider

• what are you saving for - is it only for retirement?
• assuming ISA is with a different provider then you are spreading risk being witj different companies although the risk is probably very low from a company collapse perspective
• what are you invested in, within your ISA wrapper? Cash ISA, stocks and shares?
• whilst cash seems risk free, it isn't as it's exposes to a very significant risk right now, inflation. If you put in £100 last year then it will buy you less now, probably more like the equivalent of £90 a year ago.
• most decent pension providers have a good range of investments so you can probably invest in whatever you are investing in via your ISA, in your pension
• pension contributions are tax efficient - for a basic rate tax payer this means you effectively get an extra 25% invested upfront by using a pension, more if it's a salary sacrifice (NI efficient), more again if you pay higher rate tax. That's a big boost
• will your employer match any extra contributions you make?
• the fund management charges might be higher in the pension, although in big company schemes they often are very low
• your ISA will be more readily accessibly

[Dutch1e]

@Bookclub99

This is what is happening:

A Gilt is debt issued by the UK. When the Treasury needs to borrow money, it issues a Gilt (effectively an IOU note) to investors. For example, if the Treasury issued a £100 4% coupon 5-year Gilt, it would receive £100 from an investor and give them in exchange an IOU note in which it promised to repay the investor £100 in 5 years time and in the meantime pay them £4 of interest each year. The investor doesn't have to hold the IOU note until the Treasury repays the debt at the end of 5 years. It can sell the IOU note to other investors or buy more IOU notes from yet more investors if it wants to.

For reasons I won't go into here (because it will take ages to explain) defined benefit (aka final salary) pension schemes need to invest the money they will ultimately use to fund their members' pension payments in Gilts. Lots and lots of Gilts. So many, in fact, that they borrowed money to buy those Gilts. For example, if a pension scheme had £100, it went and borrowed an extra £200 and invested £300 in Gilts. Borrowing money to invest in something magnifies gains and losses. In the example given above, if you had invested just the original £100 and your Gilt investment lost 20% of its value you would have lost £20, leaving you with £80. However, if you borrowed £200 and invested £300, then you would have lost £60, leaving you with just £40 once you had paid back the £200 you borrowed.

For yet more reasons I won't go into (because I lack the skill to explain this in layman's terms), when interest rates rise, the price of Gilts falls.

The Bank of England sets interest rates and uses them to control inflation by increasing them when inflation threatens. Because of a mix of Brexit, Covid shutdowns in China and Russia's invasion of Ukraine, there have been supply shortages of certain things (e.g., oil/gas because of the Ukraine thing). This has led to inflation because when things are in short supply their prices increase.The Bank of England has raised interest rates to combat this inflation. This led to the price of Gilts falling. A lot.

Then old Truss/Kwarteng come along and announced a load of tax cuts. Tax cuts are inflationary because people have more money to spend, further driving up the price of those things in short supply.

This meant the Bank of England had to raise interest rates even more. The price of Gilts fell further. A lot further.

Now back to those pension schemes. They are making huge losses on their Gilt holdings. Because they borrowed money to invest in those Gilts, their losses have been magnified, and the people who lent them the money are now demanding they pay it back, so the pension schemes are having to sell Gilts to repay the money, further driving down the price of Gilts... it's a vicious cycle.

To help the pension schemes, the Bank of England offered to step in and buy Gilts. By buying Gilts, the Bank of England drives their price higher, thereby stemming the pension schemes' losses and arresting that vicious cycle. However, the Bank of England really doesn't want to do this. The reason why is because the Bank of England has to print money to buy the Gilts. Money printing is inflationary... so will ultimately drive interest rates higher (to control the inflation), which will force the price of Gilts lower, so the Bank of England has to print more money to buy more Gilts to save the pension schemes... and so on. Another doom loop. That is why the Bank of England put a time limit on buying Gilts - they wanted to do just enough to buy the pension schemes some time to stablise themselves - then stop to avoid the doom loop scenario. That time limit expires this Friday.

People thought the Bank of England might extend the time limit because the pension schemes are still in a huge mess, however the governor has just said that won't happen (presumably because he wants to avoid the doom loop scenario). So now everyone is shitting themselves.

It's all horribly messy. I don't know how this will be fixed, but the only realistic options are: 1) the Bank of England capitulates and starts buying Gilts again (this isn't a good answer because of the doom loop issue), or 2) Truss/Kwarteng reverse all their stupid tax cuts and resign.

If neither of those two things happens some pension schemes may make irrecoverable losses which would mean they wouldn't have enough money to fulfil the promises they made to their members. The only way to fix this would be for the pension scheme employer to put money into the scheme (some won't have enough), for the government to put money into failing schemes (i.e., a bailout) and/or the pension schemes break their promises to their members and don't pay them as much money as they said they would when the members retire - likely a combo of the three.

I know I'm very late to the thread, just wanted to say a massive thanks. I finally get it, you're a gem!

[Pinkcadillac]

@StatisticallyChallenged

There's no simple answer to this, but a few things to consider

• what are you saving for - is it only for retirement?
• assuming ISA is with a different provider then you are spreading risk being witj different companies although the risk is probably very low from a company collapse perspective
• what are you invested in, within your ISA wrapper? Cash ISA, stocks and shares?
• whilst cash seems risk free, it isn't as it's exposes to a very significant risk right now, inflation. If you put in £100 last year then it will buy you less now, probably more like the equivalent of £90 a year ago.
• most decent pension providers have a good range of investments so you can probably invest in whatever you are investing in via your ISA, in your pension
• pension contributions are tax efficient - for a basic rate tax payer this means you effectively get an extra 25% invested upfront by using a pension, more if it's a salary sacrifice (NI efficient), more again if you pay higher rate tax. That's a big boost
• will your employer match any extra contributions you make?
• the fund management charges might be higher in the pension, although in big company schemes they often are very low
• your ISA will be more readily accessibly

Thank you!

I have both cash ISA and stocks&shares, the cash one pays almost nothing and the stock&shares isn't doing much better atm although I understand I should think of it as a long term investment.

I'm saving just for retirement. I guess my question is with only 7 years paid into my pension and another 15 or so to go, so 22 years in total, does it make sense to maximise my pension or not? I'd see it differently if I had been paying into a pension since my 20s. I'd be paying as much as possible if that was the case.

[Pinkcadillac]

Today:

Bank of England buys £2.4bn in nominal Gilts at today's operation

Rejects zero offers

[StatisticallyChallenged]

@Pinkcadillac

Thank you!

I have both cash ISA and stocks&shares, the cash one pays almost nothing and the stock&shares isn't doing much better atm although I understand I should think of it as a long term investment.

I'm saving just for retirement. I guess my question is with only 7 years paid into my pension and another 15 or so to go, so 22 years in total, does it make sense to maximise my pension or not? I'd see it differently if I had been paying into a pension since my 20s. I'd be paying as much as possible if that was the case.

When you retire your pension is extremely flexible, so there's no substantial reason not to put money in it just because you've only 7 years to go. You don't have to buy annuities anymore.

If it's only for retirement then the tax situation means that pensions generally win - you have to outperform quite significantly in another investment to make up for the amount going in to your pension being 25% + higher from the outset.

[Bookclub99]

Another thing worth noting is how yields (yield is just another word for interest rate) relate to Gilt prices. I think talking about what's going on in the Gilt market in terms of yield, as the press tends to do, masks what's going on in terms of Gilt prices.

You will read in the press things like "the 30-year Gilt yield rose by 1%". That doesn't sound like a big move, right? Wrong.

As a very rough rule of thumb, for every 1% rise in the yield or interest rate, a Gilt will rise or fall in price by the number of years left till it needs to be repaid. So in the above example, a 1% rise in the 30-year Gilt yield or interest rate means its price fell by -30%. At the moment, you're seeing moves of this magnitude in a single day (!) for long-dated Gilts (i.e., Gilts which have several decades before they need to be repaid). It's crazy.

The pension funds tend to own very long-dated Gilts (because they use them to match pensioner payroll liabilities far out in the future). This is why they are experiencing so much pain - with the long-dated Gilts, even quite small changes in their interest rates lead to huge falls in their prices.

[XingMing]

If you are 22 years off retirement, you have probably three financial cycles to tough out. And in between, there will likely be some periods when things look uncomfortable. And some that look peachy.

But bear in mind that the money you invest in tough times, ie when you worry, is buying good investments at a discount. If the dividend yield is decent (better than savings on any bank account rate as a yardstick) then you are maintaining your fund vs inflation. Right now, that's quite a sensible objective, but you have to be interested enough to take a very active interest, as in almost daily. Without taking fright at every bit of bad news.

Pension funds need to own long term securities to help smooth their returns over a 40 year cycle... you might have bought Eurotunnel shares in 1987 before it was built, but once construction was completed and the trains started running, it's going to earn money back quite steadily for a long time. And they also speculate on new companies... one might be as successful as Apple.

[XingMing]

@Pinkcadillac it is alway ALWAYS worth saving for retirement within a pension wrapper. Tax advantages all the way... you are saving for yourself and your future.

[Buk]

In addition to the problem with DB pensions, so many people have been affected by this fall in bond prices this year. Cautious investors have lost between 10-15% in most cases. Some bond funds are down 25% over 5 years!

[XingMing]

There are so few DB schemes left and so few people who will have them that I think the default assumption ought to be DC, and any thoughts based on their best investment strategies. IMVHO. it would be/ is a huge leap forward if everyone had an opinion.

[XingMing]

This very cautious investor has kept everything in cash, mindful of the inflation risk. For too long truthfully, but I am hoping to buy into the bottom of the market.

[LakieLady]

@BarbaraofSeville , thank you so much for this beautifully graphic descriptiont of how fucked things are:

"If the UK financial system and inflation is a building on fire and the BoE is the fire fighters trying to put it out, Truss and Kwarteng are like two idiots throwing petrol on the fire and rocks at the fire fighters."

Unless Truss sacks Kwarteng and gets someone half sensible in his place, I can see sterling going down faster than a bobsleigh team, and even if she does sack him, I can't see anyone among the Tory MPs who is a) capable of minimising the damage and b) would want the job in such desperate circumstances.

And the MPs can't get rid of Truss, because the rules don't allow a second vote of no confidence within 12 month period.

[EmmaH2022]

@XingMing

This very cautious investor has kept everything in cash, mindful of the inflation risk. For too long truthfully, but I am hoping to buy into the bottom of the market.

Cash is underrated IMHO.