The landscape of investing is littered with hidden risks that no risk-management committee had foreseen, nor investors had expected. While the phrase 'Black Swan' has become a cliché, the sudden rise in yields on gilt-edged stock, driven by pension funds dumping liquid assets to cover interest-rate derivative positions, may qualify as a once-in-a-generation adverse event. All this meant that Legal & General (LGEN) faced one of the most difficult communication exercises in its recent history after the Truss government's infamous 'mini' Budget blew up the gilts market, sending a backwash that swamped almost any player with even the remotest connection to so-called liability-driven investment funds (LDI), which are mainly concentrated in the defined-benefit pension segment. Now that comparative calm has returned, it is worth assessing how Legal & General handled the mini-crisis and whether this subtracts from the base investment case for its shares, which rests on a long history of dividend growth that puts it ahead of its peers. If the worries have been overdone, investors have an opportunity to pick up decent levels of income at a reasonable price.
- Escaped the LDI debacle
- Higher interest rates bring benefits
- Dividends look assured
- Management reaffirmed its earnings guidance
- Investment management looks weak
- Pressure on policy premiums
A partial recovery in its share price since the LDI debacle points to the fact that the group's communications plan worked to calm market nerves and to focus minds. In addition, a third-quarter trading update for 2022 had the effect of distancing the group from the direct impact of LDI problems. Legal & General, along with several other key players, acts as an intermediary in the market between funds looking for derivatives cover and the firms that write the derivative contracts. It has no capital exposed, nor has any allocated funds to cover contracts, which is a matter for the pension funds themselves. Managing this market is a fundamentally attractive business for Legal & General as it is a consistent source of fees from institutional clients. Pension funds rarely change their derivatives manager, unless there are operational reasons to do so, and the recurring fees bring a steady flow of revenue to Legal & General that is not related to writing the policies; in other words, the risk is minimal.