Chancellor Kwasi Kwarteng’s mini budget caused turmoil among pension funds. As one of the major players, Legal & General (L&G) has been greatly exposed to the ructions. Analysts say the developments have increased risk factors surrounding Legal & General’s business.
The Legal & General [LGEN.L] share price has fallen 26.5% in the year-to-date, hitting a new low for the year of 201.40 on 13 October, a low it hasn’t seen since climbing out of its pandemic suppression in October 2020.
In contrast, the FTSE 100 has only fallen 7.6% year-to-date. The year has been a challenging one for British stocks generally, especially given the inflationary impact of Russia’s invasion of Ukraine, but Legal & General has been especially hard-hit given its exposure to the recent upheaval in the UK’s bond market.
Between 21 September and 29 September, Legal & General’s stock fell 18.9% as the chancellor of the exchequer, Kwasi Kwarteng, sent the British economy into turmoil. Legal & General is a major player in the liability-driven investment (LDI) market, a strategy which has been hammered by the sharp rise in UK bond yields since the release of the chancellor’s mini-budget.
Pension funds have struggled to balance their assets and liabilities following the rise in bond yields. Given its heavy exposure to pension funds, Legal & General’s share price took a 14% hit in September.
Steps taken to quell investor angst
The company made moves to reassure investors by issuing a press release on 4 October regarding the status of its investment arm, LGIM.
“Recent extraordinary increases in interest rates,” read the statement, “and the unprecedented speed of those increases, have caused challenges for the pension fund clients and counterparties of LGIM's UK LDI business.” The statement referred to the Bank of England’s plans to begin purchasing long dated gilts and the resultant calming impact on interest rates.
“The steps have helped to alleviate the pressure on our clients,” the statement said, as it emphasised Legal & General’s positive Solvency coverage ratio, which rose from 212% in HY2022 to 235% to 245% as of 30 September, an increase of at least 23 percentage points. The press release also highlighted the company’s £2.3bn available cash as a marker of its strong liquidity.
Net flows remain position
Legal & General’s most recent set of financial results painted a positive picture. H1 2022 results, published on 9 August, reported an 8% increase year-over-year in operating profit to £1.16bn, and a 22% increase in cash generation to £1.0bn.
LGIM itself saw external net flows of £65.6bn, a 139.4% increase year-over-year, although market movements led to a reduction in assets under management down to £1.3 trillion. The Group’s dividend was up 5% year-over-year to 5.44p per share.
Group chief executive Nigel Wilson praised the firm’s “good start to the year”, adding that, “We have delivered for our institutional clients and retail customers, while generating good volumes and margins in a buoyant PRT market and continuing to scale LGC at pace – both in the UK and now also in the US.”
While markets were teetered by 0.6% on the results that day, perhaps due to a narrow miss on the firm’s target solvency ratio, the stock rallied 5.3% over the course of the next four trading days, back to a price range it hadn’t seen since March. Since then, however, it’s been tumbling again.
Analysts raise questions
Analysts now worry that Legal & General’s exposure to the recent market turmoil could undermine the progress they reported in August. Jefferies analysts told the Financial Times that the “risk for Legal & General is that this crisis has discredited the firm’s risk management abilities.” This could, they warned, lead to further outflows from Legal & General funds.
RBC analysts were similarly quoted as saying that there “are now also questions arising over the risk management and governance processes around LDI more generally, both with pension schemes and asset managers.”
As of 6 October, 19 analysts polled by the Financial Times yielded an ‘outperform’ consensus rating for Legal & General. Nine analysts gave the stock this rating, with three rating it ‘buy’, five a ‘hold’ and two rated it an ‘outperform’.
Among 15 analysts offering 12-month price targets for the stock, the median estimate of 315p implies a 54.3% increase from the 12 October close of 204.10p. The low target of 240p sits 17.6% above the current level and see Legal & General’s stock effectively stagnating over the coming year, while the high target of 390p anticipates 91.1% in gains.
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