Defined benefit (DB) schemes are going to have to sell more assets to retain their liability-driven investment (LDI) hedge and there is no evidence that the situation is going to stabilise in the near future, industry experts have suggested.

With the Bank of England ending its bond-buying programme on Friday (14 October), XPS Pensions Group warned that continued disruption in the price of gilts could create further systemic instability in DB funds.

Part of the problem, it said, lies in the "extremely cautious approach to capitalisation levels" taken by fund managers on LDI contracts.

Most LDI managers have settled on ensuring that the schemes they are managing assets for are insulated from a 300 basis point increase in gilt yields. With this level of headroom, they have regularly been requiring additional capital to be paid into their LDI funds as gilt yields have risen in recent days.

XPS Pensions group estimated that for every 50-basis-point movement in gilt yields, £70bn of funding is needed to maintain the 300 basis points headroom at its existing level.

This means that pension schemes are still being driven to sell assets — primarily bonds but also equities and other assets — to cover the shortfall and maintain their hedges.

If the LDI managers keep rebasing the start point for setting the 300-basis-point headroom, then rising yields will automatically lead to more requests for capital from schemes.

XPS Pensions Group head of investment, Ben Gold, said that it is clear that there is still a material risk that schemes will have to sell even more assets if they want to retain their liability hedges once the Bank of England’s support is removed.

"Without a clear mechanism to stabilise gilt yields, markets are going to continue to act out of an abundance of caution. The threat of systemic instability originating in the LDI market has not yet passed, and next week could continue to be incredibly difficult — both for pension schemes and the wider financial system.”

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