What happens when buyers become sellers? We see a significant shift in the UK gilts market as key buyers including pension funds, the Bank of England and insurers are now turning into "net sellers" of these assets.
Pension schemes have been wedded to the use of UK government debt (gilts) because of the actuarial and accounting valuation metrics used in the industry. The appropriateness of this is well debated amongst professionals and not an argument for today, but importantly it has created - until now- a very large demand for gilts.
Our analysis in the 2020 paper "the Tipping Point" showed there were insufficient gilts in the market for all the buyers to meet their needs, creating an artificial bubble in these prices.
Since then, there has been a seismic shift in market dynamics within interest rates and the UK bond market. Going forward, the net supply of gilts is expected to be nearly 3x the average of the last 10 years. Importantly, gilts will no longer find the same scale of automatic demand from key investors (BoE, UK schemes or insurers) who may now instead be net sellers of gilts (and corporate bonds). New, price sensitive, buyers will need to replace the old relatively price insensitive buyers, and that does not bode well for volatility.
More significant implications may be created by this shift, for example the issuers of GBP corporate bonds may increasingly look to issue overseas instead (following a trend seen in the equity markets), resulting in a further diminishing role in global importance of the UK capital markets. The solution to these trends will likely span successive governments, the current which has already embarked on ambitious proposals to change regulation (both Pension's "Mansion House" and Insurance Solvency II).
Implications for trustees
1. We believe savvy trustees should reconsider their portfolios today, ensuring suitable liquidity to weather a more volatile domestic bond market. But this is the obvious response, and hardly insightful.
2. More importantly, trustees should critically reassess their long term objective. Even those aiming for insurance should consider how the enormous market forces in play in this paper can be put to their advantage. For those that are fully funded already and willing to run-on for a while longer (and use surpluses for members and sponsors to enhance value to UK plc), why be tied to assets if you expect them to lose value? After all, if the value lost from investing in UK bonds is no longer a mark to market effect, but true value possibly lost forever it suddenly becomes far more important.
Al Greenlees
Head of Investment Strategy - UK
Calum Edgar
Associate - Investment Strategy - UK
