Alex Waite
The gilt yield is generally accepted as the benchmark for risk-free returns. It’s what Government debt over various time-frames will reward you with and it is accepted as a benchmark because the chance of the UK Government defaulting on the debt is negligible.
It is also accepted as a benchmark because it is not subject to the vagaries of supply and demand because its major stakeholders – the Government and pension schemes – are in equilibrium – supply meets demand.
This equilibrium is being challenged according to LCP’s Alex Waite, who sees a potential for a large scale sell-off of gilts by pension schemes as they prepare for and enter into deals with insurers which will see pension liabilities switch from being matched by gilts to being matched by corporate bonds.
“The anticipated sell-off would naturally drive down gilt prices and hence elevate yields, potentially accounting for the observed circa 0.5 per cent pa discrepancy relative to other markets.”
High yields = high discount rates = happy days on solvency. But is the anticipated sell-off as likely to happen as the market imagines? If it isn’t , then current solvency may be measured against a benchmark which may be a bit skew-whiff.
This may all sound a little academic and pension-nerdy, but there’s a bigger problem associated with gilt pricing than just vagaries in pension fund valuations.
One of the Chancellor’s golden rules, mentioned in his Mansion House Reform speech was that the reforms supported the integrity of the gilt-market.
It is hard to see how a wholesale sell off of gilts as DB schemes move to buy-out could do anything but destabilise the gilt market as Alex Waite suggests,
“For investors and pension schemes with a strategy to hold their gilt portfolio to maturity, the gilt yield arguably remains a reliable indicator of the ‘risk-free’ rate that they can expect to receive.
However, the billion-pound question remains: Will pension schemes stay the course to redemption? If market sentiment indicates a shift, the gilt yield’s reputation in the pensions industry as the de facto benchmark for the long-term ‘risk-free’ rate could well be due for a reassessment
“As we step into the new year, it’s clear that, while the UK government’s commitment to honouring gilt coupons is not in question, the market participants’ commitment to holding these instruments might well be.”
LCP are not just respected pension actuaries but seen as pivotal to the “de-risking” of DB pensions through buy-outs and buy-ins. Their questioning the reputation of the gilt-rate might have been considered heresy until recently, right now it looks like common sense.
