The CIO of Odey Asset Management, shares his thoughts on recent events in
the UK economy.

There was a time when markets were in the ascendancy, when they ruled, rather than were ruled. One of the sadnesses for those of us who have been around a long time is that we have watched a great ocean become a lake. We have watched politicians increasingly understand how to minimise the influence of market economics on any policy they might have had. My sense was that the culmination of all of this was when Covid came along and we saw that governments realised they could do anything they liked and markets could not basically fight back. 

Once we reached this point, it was but a short step to watching my old graduate Kwasi Kwarteng do his mini-budget in style on that Friday and, by the way, Kwasi learnt absolutely nothing when he was working for us, but that it was very, very wrong that he should be blamed for what happened on that Friday. As we all now know, but had perhaps only an inkling at first, is that what we are in with liability-driven investment (LDI) is the same kind of crisis that you could argue we had with the whole banking crisis of September 2008, when banks’ loan-to-deposit ratios reached 130%. 

What is so very bad about this situation is the corruption of the pensions industry. We always believed that part of the City of London’s strength was that you had a huge amount of unleveraged capital which was at the heart of it and that unleveraged capital could not be assailed. Remember in the old days no pension fund could borrow money: they could invest in companies that borrowed money, but they couldn’t borrow money themselves. In the same way, with your personal pension, you cannot buy a hedge fund, because that would be dangerous. What we see with the pension funds is that something that was meant to provide security by matching the duration of liabilities to that of assets – LDI – turned into something very bad. 

Once we saw defined contributions coming in and defined benefits going out, suddenly the actuaries were able to come in and start to talk a different language: “Hey, you might have got these assets, but think of what those liabilities could be in 20 years’ time”. As soon as you start looking in those terms, the only way out, and it was a sensible idea, was LDI. All these things start as a good thing and end as a bad thing. In that early period in 2003, the actuaries were saying: “Hey, look, your assets are at 70 and your liabilities are at 100 if you take them through. Why don’t we invest on the basis of the 100 bonds, so that when interest rates, if they come down, won’t have you suffer from liabilities creeping up much faster than your assets can possibly handle.” And that was precisely what happened in 2003. 

However, in 2020, when we went into this up-cycle in inflation and this fall in bond yields, with this kind of leverage still in place, it really showed zero understanding of markets. It really drives home why the last 15 years have been potentially very devastating in terms of how significantly we have lost the skill set to understand what leverage and risk basically does, and the fact that markets and cycles can come back and be as ferocious as they are.