Robert Stheeman, CEO of the UK Debt Management Office, tells Taha Lokhandwala about the importance of ongoing dialogue with institutional investors
The economics of sovereign debt will always be an important question for large pension funds given the natural fit between longer-dated government bonds and pension liabilities.
In the UK, managing the government’s ongoing financing needs falls to the Debt Management Office (DMO). This executive body has two interlinking objectives – meeting the government’s needs cost-effectively, and taking account of risks. Responsible for seeing this through is the chief executive, Robert Stheeman.
The DMO took responsibility for debt management in 1998, with Stheeman appointed in 2003 after several years’ in commercial banking based in London and Frankfurt. He led the organisation as the UK’s debt swelled at the height of the financial crisis, and as its customer base took a drastic turn when the Bank of England (BoE) intervened with quantitative easing (QE).
Pension fund and insurance investors accounted for up to 55% of the £440bn (then €654bn) outstanding Gilt issuance in March 2007. Seven years later, while holdings increased, these institutions fell to third in the customer ranking, accounting for 26% of a much larger £1.4trn pie. Overseas investors accounted for £413bn and the BoE’s QE holdings for £367bn.
But Stheeman says pension funds and insurance companies remain a core part of the DMO’s investor base. The DMO maintains an active relationship with its domestic institutional investors, with quarterly consultation meetings, not just with market makers but end investor groups – and the organisation is keen to hear directly from its customer base.
“This does not mean we can always do exactly what they want us to do,” Stheeman says. “However, we can understand their strategies and factor this in.
“In some cases they will come in and see us, not just in consultations, but bilaterally as well. Some of the more active institutions may have direct contact with the dealing desk, and we talk to them to understand their preferences. That dialogue is important to us.”
Stheeman’s view stems from the organisation’s own objectives of cost minimisation. Pre-crisis the UK government managed a fairly inverted yield curve, and annual issuance of around £40bn-50bn. This meant it could issue longer-dated paper while completely satisfying its cost-minimisation objective. More recently, the yield curve has steepened making shorter-term notes much better value.
“All of our decisions are ultimately judgments on how best to reach our objective,” he says, pointing to the need to achieve cost minimisation while taking risk into account. “If our only objective was cost minimisation, given the shape of today’s yield curve, you could argue [a case] to issue everything in treasury bills. Obviously we are not going to do that. It would create a greater refinancing risk than we would be comfortable with. It would alienate the pension fund industry.
“So we analyse the yield curve and try to establish whether it suggests a ‘preferred habitat’ for investors, and then balance that against key risks such as refinancing, interest rate and liquidity.
“We have to look at the volatility of the cost, versus that risk. Effectively, we try to come up with a strategy that balances all these things sensibly and allows us to borrow sustainably in the medium term.
“In other words, if we do not nurture our investor base, and supply what it wants, they may abandon our market altogether. These things are a balance,” he explains.
Stheeman emphasises that the DMO will never completely satisfy the domestic pension fund industry with longer-dated issuance. Key to this is market liquidity, and the ability to sell down short-dated notes whenever the government needs to.
As of the end of June 2014, 37.5% of the £1.3trn in debt outstanding was in holdings longer than 15 years in duration. Of all issuance, 23.2% is index-linked and 24.6% what the DMO calls ‘long-conventional’.
But debt issuance is projected to fall. How will this affect pension funds?
Stheeman says it again depends on the shape of the yield curve – if it inverts again as it did prior to 2007, longer-dated issuance remains cost effective, while a steeper curve makes it much more difficult.
He says: “I do not like to speculate on future issuance strategies, but my guess is probably [that we will] continue issuing across the board, although there may well be some shifts in maturity if demand patterns change.”
The National Association of Pension Funds (NAPF) has longed called on the UK government to increase issuance, a call often falling on deaf ears. In July, a £5bn syndication of 45-year index-linked Gilts saw interest at £14.5bn, despite a negative yield of 5.3bps a year.
Stheeman says linkers remain a core part of the DMO’s remit and that, in percentage terms, no other sovereign government has issued as much. “We are very happy to issue inflation-linked Gilts. We think they are very good value for money.”
But as he regularly stresses to all of his customer base: “We cannot do this exclusively.”