Mess up gilts – you mess with pensions
Ah gilts – my pension provider decided that as I was nearing retirement they’d put the majority of my fund into “safe” 15yr Gilts. I retired last August. Since then my DC fund has lost over 25% in value thanks to the fall in gilts.
— 💙 Living with Covid doesn’t mean ignoring it (@Davrobin) September 23, 2022
The idea that people are safer in Government Bonds (known as gilt-edged stocks) is well established. Gilts represent the “risk free rate of return” – until that is , you are invested in a “gilts fund”.
When the yield on gilts rises, the value of the gilts you own falls. Why would anyone want to buy your pieces of paper promising to pay a fixed rate of interest when they can get a better rate from putting the money in the bank?
Normally the impact of a change in the markets may alter the “yield” on a gilt a tiny amount. But not this morning.
This is how the FT reported market reaction to today’s mini-budget.
UK government bonds sold off sharply and the pound hit a new 37-year low against the dollar as investors worried that Kwasi Kwarteng’s tax cuts and energy subsidies would place Britain on an “unstable” fiscal trajectory. (my emphasis)
The 10-year gilt yield surged 0.27 percentage points on Friday to 3.77 per cent, bringing its rise for the week to more than half a percentage point. This week’s rise marks one of the biggest increases in long-term borrowing costs on record.
Sterling fell on Friday below $1.11 for the first time since 1985, while the FTSE 100 share index slid 2.4 per cent. Friday’s heavy selling in gilts and the pound came after Kwarteng, the chancellor, said the government would scrap the 45p top rate of income tax, replacing it with a 40p rate.
I found Chris Philp’s preemptive tweet rather funny
Great to see sterling strengthening on the back of the new UK Growth Plan https://t.co/Ec8tgXkgKd
— Chris Philp (@CPhilpOfficial) September 23, 2022
Until I found out that Chris Philp is part of the Treasury Team that put the mini-budget together.
Minutes after his tweet, sterling fell almost 2% to a 37-year low of $1.10 as the yield on ten-year government bonds rose from 3.5% to 3.75%
Ooh look, Chris.
The currency markets’ reaction to the “new UK Growth Plan” you so eagerly welcomed.
Any thoughts, given your earlier “confidence”…? pic.twitter.com/aa7hC9qfGr
— Chris Shaw (@The_ChrisShaw) September 23, 2022
The approach taken by the Chancellor and his colleagues reminds me of the English Cricket team this summer. The only difference is that the English Cricket Team were winners.
So what does it mean for your pension?
Well if you are in a pension where someone else takes the risk, you are in clover, the cost of funding your liabilities has gone down and your security of getting your pension paid has gone up.
The not quite such good news for DB schemes that have followed TPR’s advice and de-risked – using Liability Driven Investment is that some of the derivatives will now be so underwater that they’ll need cash to meet margins. Keating and Clacher estimate these calls to be c£60bn – which may mean some schemes having to force-sell assets.
Open pension schemes like LGPS, USS and Railpen will be benefiting from immunity to such cash-calls.
But if you are – like @davrobin above – finding yourself owning a load of gilts because your pension scheme thought that you’d be well protected in a risk-free asset – you will be nominally 30% poorer than this time last year.
A quarter of a point rise in gilt yields equals a 5% fall in the value of the gilts you hold.
But heh! – that’s ok! – because you’re about to buy an annuity!
Annuity rates were approx 5.2%* at the beginning of the year. They are now at 6.5%.
We could see rates in excess of 7% by the end of the year.
*based on a 65 yr old, single life, level payments.
— Mark Ormston (@mdmormston) September 23, 2022
which is about 30% cheaper to buy than this time last year . You are just like all the pension schemes that have gorged on liability driven investments – rather poor – but super solvent.
Except , there’s this snag. You probably decided that when the Chancellor in 2014 said “nobody would have to buy an annuity again” , you’d never buy an annuity – ever.
And rather than congratulating yourself on hedging your annuity purchase, you are cursing the day your pension trustees put you in a lifestyle programme and into a 15 year gilt fund. Happy days eh @davrobin.
One of my friends, who has been active in the fixed interest markets for five decades phoned me to tell me that this was the most stupid budget he had experienced in those 50 years. But then he is a socialist.
Worth repeating. Take all the tax changes coming in over next few years and:
If your income is < £155k, you lose
If your income is > £155k you win
If your income > £1m you gain more than £40,000 https://t.co/TkkGIKvNrl
— Paul Johnson (@PJTheEconomist) September 23, 2022
Government borrowing costs, which were supposed to fall with inflation which is being bought down with Government debt, is now through the roof. And it’s not just the Government
Following the chancellor’s announcement, markets were pricing in 0.75 percentage point rises at each of the next three BoE meetings, taking rates to 4.5 per cent by Christmas.
So what has Trussnomics done for your pension?
- If you’ve been life styled , your pension could be 30% poorer for being in gilts
- If you’ve recently bought an annuity, you got your timing wrong – (unless you are on a fixed term – in which case look at your options)
- If you are invested in the UK; then don’t sell up and go abroad – you can’t afford it anymore
- If you are invested abroad and your fund manager has hedged your currency exposure – you are in deep doo doo
- If you are invested abroad and your fund manager hasn’t hedged you – you’re ok
- If you are a saver and paying tax at 45% , invest this financial year to max your tax breaks by topping your pot up.
- If on the other hand, your getting pension credit, your pension savings have just reduced your benefits.
- The surge in salary sacrifice/exchange may lose some momentum as the November increases in national insurance are dropped.
- Cuts in the additional rate on dividends and in corporation tax may make pensions less attractive tax shelters for small business owners
- Meanwhile, in a small sop to basic rate taxpayers, the drop in tax relief to 19 per cent on pension contributions will not apply until April 2024.
- The removal of performance fees from the workplace pension charge cap won’t make the slightest difference to asset allocation or pricing of such funds.
- The rise in the gilt yield will bring the DB transfer market to a halt.
- And an announcement that the government will replace Solvency II regulations with “rules tailor-made for the UK” is likely to make annuities and bulk-buy out more affordable still
- The absence of any coherent statements on environmental issues suggests the emphasis for new investment will be on growth not sustainability.
And for all those who think their pension is their property, ask yourself just who will be able to afford the mortgage to buy it.
Biggest tax cut in 50 years.
Largest one-day spike in gilt yields in 30 years
Lowest £/$ exchange rate in 37 years
Lowest consumer confidence since records began
How’s your Friday going?
— Alistair McQueen (@HelloMcQueen) September 23, 2022
Important to have been reading and taking in what Keating and Clacher have been saying the last year or so. Its only a modelling assumption that says gilts are risk free. They are not. They were terrible value last year, so you should have an issue with anyone who advised you to buy something with such terrible value.
I will pass this observation on to Con and Ian who are currently sitting with ice-packs on their foreheads taking this in
Another thing that Gilt Rates matters for is the notional income for Pension Credit. That’s calculated using 15 year rates. The result, for a 70 year old with £25,000 of pension savings is that their benefit is now £16.67 a month less than it would have been a month ago.
That’s extraordinary Gareth
Should have used and IFA but at least you can offset the IFA drag against to your fund loss
The immediate hit to these changes will be further margin collateral calls – around £60 billion as best we can tell.
The most immediate hit with be from margin collateral calls – around £60 billion as best we can tell. I did try posting this earlier but that appears to have disappeared in the ether. By the way, I bought some 1/8th ILGs 2068 this morning at an effective clean price of 94.75% – that is about RPI + 25 bp – down 71.7% from its December high.
If we ask the question: whither gilt yields, we should note that the 2023 issuance calendar just rose from £62.4bn to £193.9bn – yes tripled! How much foreign demand should we expect given the weakness of Sterling? Can we really expect the Bank of England to continue with its proposed quantitative tightening (sale of its holdings) against that backdrop – which really leaves only interest rates available to them – 5% ++ anyone? – This is all beginning to look like the market problems of my early career.
Don’t drag Victorian politics into this Con
So, hands up, who bought the 2068 ILG at 335% last December!
I would like to know the answer to Chris Giles question. Incidentally, my purchase of the 2068s at 94.75 was looking awful late in the day – I was offered some more at 90 and left with the impression that a close bid would have bought them.
The Debt Management Office (DMO) issued £1.1bn 0.125% ILG 2073 at 355.94 (real yield minus 2.388%) on 24 Nov 2021 and sold a further £1.8bn at 241.84 (RY minus 1.645%) on 28 Apr 2022. The mid-market price this morning is 66.71. Rishi Sunak, take a bow!
Did the buyers last November have inflation linked liabilities (capped at 5% pa) and expect the rate of inflation to exceed 7.4% pa over 52 years?