All UK government bonds which provide investors with inflationprotection closed with a negative yield-to-maturity yesterday (23rd November). Robert Gardner, Co-Chief Executive Officer at Redington, the investment consultancy, highlights reasons for the move andits impact on UK pension schemes.
“There are a number of factors behind Index-Linked Gilt yields turning negative – long-end nominalyields are being pushed lower by the deteriorating economic outlook; expectations of further gilt buying by the Bank of England under its asset purchase programme; flight-to-quality status of UK giltsduring a European sovereign bond crisis; high spot inflation outcomes with CPI and RPI both above 5%; demand from index-linked money managers at Debt Management Office (DMO) auctions.”“This move in real yields will force the mark-to-market value of liabilities higher and higher for all schemes and lower funding ratios for those with a low hedge ratio – approximately 80% of schemeshave a hedge ratio of less than 50% and are likely to see a significant fall in their funding level. Current yields highlight more than ever the need for a clearer framework and the governance to ACT (Agility,Control, Transparency).”
Regarding what actions can be taken in this environment, Gardner comments, “Pension schemesshould maximise their toolset in order to capture opportunites. We have seen an increasing use of Gilts, Swaps, Repo, Total Return Swaps and Swaptions for liability hedging purposes, as well as theseparation of inflation and interest rate hedging. Some schemes are using Liability Driven Investment (LDI) asset managers with the authority to make active relative value decisions. There is also theoption to source long-dated inflation-linked assets, such as water companies or social housing.“
“The outlook for real yields is uncertain. Real yields could be forced even lower should the reasonsabove continue to push nominal yields lower. Fund managers who are short duration versus their benchmark may get stopped out and forced to buy-back the bonds. It is worth looking to separatenominal and inflation hedging and build up this protection tactically.
“It’s time to adjust the sails and prepare for low nominal and real yields for a number of years.”
|
