Pension funds stick with gilts for safety

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Pension funds will sell off parts of their gilt portfolios in extreme circumstances, but generally they are far too wedded to them to do that. The rational investor might look at the high value of gilts and see better opportunities in higher yielding assets, but the liabilities on private sector pension schemes tend to be too mature to contemplate this.

Office of National Statistics figures show that throughout 2011 and the first half of this year pension funds were net buyers of gilts despite their record value and equally low yields. By contrast, insurance companies were consistent sellers over this period and instead have increased allocations to overseas securities.


The only blip came in the third quarter of 2011, when pension funds sold off more gilts than they bought. Fears over a euro meltdown were at their highest in August and September 2011, creating an opportunity too good to be missed for some funds to sell gilts high and buy equities cheaply.

Currently it is hard to find anyone advising this course of action. Mark Herne, managing director of investment consulting at Redington, does not know of any of his clients taking an active view on gilts owing to their importance as part of their liability management programmes. He says: “Although gilt yields are historically low, they are not historically low on the forward curve, which has moved higher recently.”

Alastair Baillie Strong, head of investment strategy UK for the fiduciary manager Mn Services, says: “Whilst medium term forwards predict a return to higher rates along the curve, schemes cannot afford to ignore the risks.

“There is a very real possibility that continued economic uncertainty and investor risk aversion result in rates rising less quickly than is currently expected.”

But, while pension funds are not opportunistic sellers of gilts, this has not excluded them from purchasing high yielding assets from other sources.

Schroders has seen clients contemplating broadening their fixed income mandates away from pure gilts. John McNeill, investment manager at fixed income house Kames, says a spectrum of higher yielding asset classes have appealed, according to each pension fund’s appetite for risk.

“For the more risk averse, this is high quality grade credit which has been a very good asset class to be invested in,” he says. “Some have invested in high yield and some pension funds have looked at assets on bank balance sheets which have bond-like pay-offs.”
Insurance companies and pension funds have been looking to buy these from the banking system, Mr McNeill adds.

The figures speak for themselves. Global mezzanine debt is yielding around 11-13 per cent and leveraged loans yield 5-7 per cent, according to JPMorgan Asset Management. And Aviva Investors is boasting a 5.5-6.5 per cent yield on its conservatively invested high yield bond fund.

The purchasing of leveraged loans and mezzanine debt from banks has not been done to match liabilities. The £2.5bn Royal Mail Pension Plan, is to make a 2 per cent (£50m) allocation to a manager who will have discretion to invest in a range of private debt – such as real estate, infrastructure refinancing, company loans and the secondary loan market.

The allocation will form half of the fund’s 4 per cent allocation to alternatives within its return-seeking strategy, but is not being funded from disinvestment in gilts or other liability-driven investment assets. Paul Sweeting, European head of the strategy group at JPMorgan Asset Management, has seen other funds move in this direction.

“From the point of view of what we are selling I know that mezzanine loans and leveraged debt are popular. They are never going to be 20 per cent of a scheme’s funding but while they were unheard of a few years ago they are attracting a lot of interest now.”
He also joins the chorus of those cautious of an active gilts strategy. “It is not the case that if you sold your gilts today you would expect the price to halve in the next year and be able to buy them back at a big profit. It is going to be a low interest rate environment for some time.”

At the National Association of Pension Funds’ October annual conference, Tom Merchant, chief executive of the £34bn Universities Superannuation Scheme, revealed he was looking at a five year recovery for gilt yields.

Indeed, Craig Inches, government bonds specialist at Royal London Asset Management, believes that, while investors should be looking at a small rise in gilt yields over the next six months to a year, there will not be a return to “normal” yield expectations.

[flaminmoses]

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