I am pleased to read this excellent article by my friend Calum Kapoor in Asset Owner Exchange.

This is not an old man like John Kay or Con Keating, explaining the way that pensions shape the economics of Britain, this is a young man trying to make a pension system that is disappearing before him, one that he has and will never be in. Let me explode in size the caption above…

While we were looking into the state of UK equities recently, Steve Hodder, a partner at LCP, brought a slightly concerning statistic to our attention:

We are talking orange and boy has it been squeezed in the past fifteen years

Two reasons as to why this should keep us up at night: first, a concentrated buy-side market surely presents risks when there are shocks, as seen in 2022 under Liz Truss’s short-lived stint as UK prime minister.

Secondly, as DB schemes become fully-funded what happens when a stable customer base slowly but surely dries up?

Matt Tickle, chief investment officer at Barnett Waddingham, says: “UK DB PLC has pretty much bought all the gilts it needs to buy to meet those liabilities. It’s not 100 per cent and there are some schemes that will still be buying at the margins, but fundamentally they’re there.”

The Office for Budget Responsibility shares these concerns:

“The gilt holdings of pension funds will decline in the coming years as most private sector DB pension schemes are closed to new members and will eventually wind down. The rise of DC schemes in their place is unlikely to make up for the resulting decline in gilt demand. DC schemes tend to have portfolios dominated by equities. They therefore hold a smaller share of their assets in gilts compared to DB schemes, particularly given the fall in annuitisation rates among DC pensioners over the last decade.”

The OBR estimates the value of gilts held by DB pension funds is closer to $803bn, with most of this in closed schemes. And the OBR raises another issue: the boom in buy-outs.

It said: “Annuity providers and insurance companies have a much lower share of assets in gilts than private sector DB schemes therefore buy-out transactions tend to reduce demand for gilts.”

And as everyone knows, the past few years have seen a bumper amount of DB buy-out: last year saw 299 DB buy-ins valued at $63bn completed.

This was the largest amount in a single year, according to Hymans Robertson.

I don’t mean to sound generational, but there are generations of pensioners who are relying on gilts to get pensions and a generation coming behind them , such as Calum who aren’t and won’t be and they are living in a country where the connection between pensions and the Government’s financing are being weakened.

I know there are those (some within the FT organisation in which Calum works) who decry the Government’s threat to mandate pension funds to invest in the UK, but you can see why Government is making sure that the pensions that the tax-payer subsidise, invest in future to replace gilts with loans and equity investment in Great Britain.

I am a fan of Calum and the way he takes on pensions seriously. We are friends, I lend him my experience, he lends me his energy and mental vigour and we are both optimists.

In the body of his article, he explains that normally the transfer of pensions to insurance will mean a sharp sell off of gilts in favour of cheaper corporate bonds (often foreign bonds) but that right now the pay-out on long-term gilts is so high that insurers are maintaining higher amounts of the gilts they buy in  and out from pensions. This is a kind of arbitrage and not a long-term strategy, long-term yields will reduce as confidence in the Government returns. We need a new pension contract for that to happen.

In the short-term Government is  having to pay more income on long gilts as demand from pension funds decreases and so it is switching to cheaper shorter  term gilts.

Callum explains to his generation that in the long term, pension sectors are going to do less and less “guaranteeing” and that will mean less and less long dated gilts.

The OBR’s central projection is that the pension sector’s gilt holdings will fall from 29.5 per cent of GDP in 2024-25 to 10.9 per cent of GDP in 2073-74.

To make up for the decline of pension funds buying gilts, the OBR says it needs to bring in more gilt buyers

“attracting these marginal investors is likely to require somewhat higher yields”.

What’s not clear to anyone, is who these investors are going to be, if not the Government. Going back to the chart above, we can see investment in our gilts from around the world increasing but right now it’s still the Bank of England holding them – the legacy of Quantitative Easing it is trying to undo by “tightening”.

I am not an economist and even the economists find it hard to work out what that chart will look like in ten, twenty or thirty years. But we won’t be seeing pensions providing long-term finance to Britain  unless we return to guaranteed pensions (unlikely).

We talk about the menace to Government of sending growth money overseas for the sake of “diversification” but this is about the menace to Government of the long-term loss of support through gilts of Government borrowing by pensions – through gilts.

The fragile balance between taking tax incentives and giving support to the British equity and gilt markets that has been in place for 75 years is unhinged. The door is flapping in the wind and we need a new contract. That is why Government is threatening to mandate co-operation with the Mansion House agreement.

Calum is right to point to the dead end facing long-term gilt investment by pension schemes. CDC, annuities and “flex drawdown” are not going to replace DB pension funding nor should they. We need a new contract between pensions and Government.