Three years on from the mini-Budget, industry experts have emphasised that UK pension schemes remain in a "much stronger position", although challenges remain, with some warning that while the system feels "safer", the real test is yet to come. 

UK defined benefit (DB) pension schemes faced significant volatility after the mini-Budget in 2022, as a sharp surge in gilt yields triggered huge collateral calls on liability-driven investment (LDI) portfolios held by many UK DB pension schemes, which later compelled the Bank of England to temporarily buy long-dated gilts to calm the market.

Isio chief investment officer, Barry Jones, pointed out that UK DB pension schemes are now in a much stronger position, as higher interest rates and the recovery in risk assets since 2022 have boosted funding levels, giving many trustees the chance to lock in the gains. 

"Schemes are holding more gilts and high-quality credit, while reducing leverage in their liability-driven investment portfolios," he continued. 

"Furthermore, the conversation has moved on from how to get to full funding to a conversation of surplus sharing between sponsor and members and Run-On.
 
However, Jones admitted that "challenges remain", as some schemes are still tied up in private assets that take years to mature. While they could sell at a discount, most are choosing to wait it out. 

"In the meantime, liquidity is being rebuilt, and portfolios are being adjusted, but structural constraints remain," he continued. 

"LDI looks different today. Schemes now run with much larger buffers to avoid the kind of forced gilt sales that dominated headlines in 2022.

"The question is whether these safeguards are more than just a comfort blanket. In the last bout of volatility, managers often asked for more collateral rather than relying on buffers. Repurchase agreements offer an extra backstop, but whether the system can truly withstand another shock remains to be seen." 
 
Given this, Jones warned that although "the system feels safer today, the real test will be how these new safeguards perform in the event of another bond crisis". 

"Understanding how and when buffers can be used will be key to avoiding history repeating itself," he said. 

Adding to this, AJ Bell head of investment analysis, Laith Khalaf, noted that, as in 2022, the actions of pension funds do raise questions about the yields on long-term government bonds.
 
“DB pension funds have historically been keen buyers of long-dated government bonds, but the switch from DB to defined contribution schemes means that over time the gilt holdings of the pensions sector can be expected to decline, especially seeing as annuities have become less popular since the pension freedoms were introduced a decade ago," Khalaf continued. 
 
“This does present a headwind to demand for long-dated government debt, which is also exacerbated by the government’s drive to get pension funds to invest in private assets such as smaller companies and infrastructure.

"If the government is successful in this drive, it will serve to lever pension schemes out of their traditional habitat of UK gilts. As they say, be careful what you wish for.”
 

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