Gilt index event ups liabilities by £9bn
UK - The liabilities of pension funds with FTSE 100 sponsors are likely to have risen by £9bn (€11.4bn) in the last two weeks as the five-year anniversary of a single index-linked gilt is forcing almost all passive asset managers to sell the asset and rebalance their bond portfolios.
Today (15 August) is the five-year anniversary to the maturity of the 15 August, 2013 index-linked gilt so it will drop out of the five-year ILG benchmark used by most asset managers from Monday, forcing asset managers to sell the asset and reinvest in longer-dated gilts or try and rebalance their portfolios.
The requirement to sell the asset and buy long-dated gilts has pushed up the liabilities for pension funds attached to the UK's top 100 listed companies by £9bn on an IAS19 basis or £15.5bn flat to LIBOR, according to data compiled by pensions consultancy Redington Partners, and investors are having to sell the 2013 gilt when there are few buyers in the market, while subsequently buying long-dated gilts when yields are at a low.
While the IAS19 calculations ignore any change in credit spreads, data reveals the real yield of the UKTi2037 ILG has fallen by 18 basis points since August 1, from 68bps to 50bps, and the duration of the five-year benchmark has been extended by 1.4 years simply by removing the 2013 gilt, putting liability valuations under pressure straight away because there is little room to buy new liquidity at a reasonable price.
The index-link gilts market has more doubled in size since 2001, as Debt Management Office data shows it has grown from £34.2bn to £82.9bn.
But experts are concerned there are not enough investors to absorb such a large amount of debt as the 2013 ILG accounts for over 9% of its market.
Asset managers are having to act on the change to their benchmarks as the removal of this single gilt from the index therefore leaves asset managers' benchmarks underweight and it has pushed the duration of the five-year index out from 14.15 to 15.55 years - where they extend their gilts market benchmark to 15 years.
Banks are also said to be showing little interest in buying the paper so the difficulty is in deciding whether to sell in one chunk by the end of today, or attempt to sell in small sums and buy that long-dated paper, experts say.
To make matters worse, they could find they may need to buy back the long-dated gilts (2037, 2055) ILG at a later date and at a further loss - increasing the pressure when pricing is already tight - as demand for existing paper is likely to push yields down further, suggested Rob Gardner, partner and co-principle at Redington Partners.
"This indexation has created a huge amount of activity today and the preceding target to reach this date," said Gardner,
"Forced sellers of these gilts and forced buyers of the long-dated gilts means there is a double whammy. The long-dated gilts are very expensive, and by selling that 2013 gilt most funds have immediately gone underweight of the index without doing any trades.
"There is a September auction of the 2055 ILG and everyone thinks it will be oversubscribed, so [asset managers] may not be able to get access. It is then the big blind calling the bluff because if the gilt value drops even lower, [asset managers] could be forced to buy back which will exacerbate the problem. The yields have already fallen to new lows, low because of this long-dated duration. But it could push it even lower," he added.
The true impact on pension funds is not likely to be felt until the September auction has passed, but investors are now under serious pressure to manage the situation, as Redington suggests a 10-15bps fall in the real yield will see asset managers break through their tracking error limits.
And this is all when the "very yield valuation liabilities are measured by are being pushed even lower", according to Gardner.
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