One of the many consequences of Lehman Brothers' collapse just a few long weeks ago was that it highlighted the various counterparty risks to which pension funds and managers are exposed.
Pension funds are not immune to the current crisis and with their overriding objective to pay pensions long into the future, it is a truism to say they must remain faithful to their principles as long-term investors. But the collapse of Lehman Brothers in the early hours of 15 September - the largest corporate insolvency in history - had a profound effect on financial markets, one that we have experienced in recent weeks. But this is not only true in terms of markets.
That fateful collapse revealed that many managers and pension funds had exposure in that their counterparty was Lehman. Or that collateral was invested in a Lehman money market fund. Short term, it has not been too difficult to unwind these positions. But a prudent strategy would be to review counterparty risk as a whole. We wanted your views on the various issues that have come to light in recent weeks.
Certainly, stock lending may no longer be viable at all given the short-selling bans imposed throughout the world, mainly for financial stocks. So we asked schemes around Europe to tell us what issues they had seen vis-à-vis collateral and in more general terms, how the current financial crisis affected them. Many funds think it is no longer worth the candle.
Pension funds from across Europe responded to IPE's latest Off The Record survey, of which just over 40% said they did not engage in any kind of arrangements requiring collateral. One-third of respondents used interest rate swaps and 39% had some form of stock lending. Some 20% of respondents admitted they had ceased stock lending as a result of the current financial crisis.
How have arrangements suffered? In fact, the vast majority, 75% to be exact, said they have yet to experience any problems with their collateral.
But for the remaining quarter, there is a different story to tell. Half of these were working with the now defunct Lehman Brothers - a situation that requires no more explanation. One scheme said it had instructed its lawyers to make "the situation more clear". Still it is refreshing to know that most schemes' stock lending and other collateral raising activities remained immune to the current fiasco.
Although they said they face no problems yet, almost half those that employ collateral feared they may do in the future as the long-term implications of the credit crunch make their way through the system. With that in mind we were keen to see if the current problems had forced schemes to take an extraordinary review of their investments and change their portfolios accordingly.
The question of whether or not investment strategies would need to be reviewed reminds us that most funds have their eye on the horizon as long-term investors, just as they should. But there were three discernible categories of respondent.
Firstly, 27% of respondents said they would not be changing their equity allocations. At first glance, you could be forgiven for thinking this meant they were sitting pretty and saw no need for change however bad the crisis.
However, many will simply not rebalance their equity allocations - meaning they are effectively tactically underweighting. What about their other asset classes? Most of the funds claimed they were long-term investors and as such were in no hurry to review their investments.
Another admitted at least having to take extreme pricing into account, while one said it only had a 15% equity holding anyway. So the maturity of these schemes could mean they have little tied up in company stocks or the opposite: they are very young schemes that can afford to think way into the future.
The next group seemed to display a strong sense of confidence in their investment strategies as they merely said they were undergoing a strategic asset allocation review anyway, so they envisaged making changes as part of their normal operations. None of this group, which represented a quarter of the funds involved, divulged details of the changes planned or what had been discussed up to now. One admitted having to bring its review forward as the financial crisis "gathered momentum".
Food for thought, no doubt, and an interesting wait to see how radically or not pension schemes have had to rethink their approach to their investments as a direct result of the current downturn.
Finally, just under half of those surveyed appeared to take a more pragmatic approach and admitted they were making "active" tactical changes to their investments to ward off the losses their current allocations could incur as a result of the current market turmoil.
Fixed income instruments such as distressed debt and high yield bonds seem the likely winner. But as one scheme put it: "Our assets are already negative."
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