UK schemes scramble to buy linkers
The Bank of England says UK pension funds are buying index-linked gilts at virtually any price – caught in a vicious circle of falling yields and falling funding ratios.
The central bank said demand for index-linked gilts from UK schemes “may have become relatively price inelastic” due to the shift to liability driven investing and the demands of created by the Pension Protection Fund.
“To the extent that returns on index-linked bonds influence the discount rates that funds employ to assess their future liabilities, the recent falls in yields could have further reduced funding ratios,” the bank said in its latest quarterly report.
“In turn this may have reinforced the demand for index-linked gilts and driven their yields even lower.”
The BOE said funds could also gain long-term inflation-linked cash flows by using the inflation swap market.
It said: “Market contacts have reported significant receiving of long-dated inflation by UK pension funds in the sterling swap markets – both linked to RPI and LPI (limited price indexation.”
And some dealers and fund managers have also been marketing pooled funds offering pension schemes long-term real returns, perhaps backed by inflation swaps.
“Where dealers have paid inflation in the swap market, they too may have purchased index-linked gilts to hedge this exposure, although some dealers are said to have used other hedges, including index-linked loans to finance private finance initiative projects and property investments.”
BoE said that some of the recent buying of long-dated bonds could have been associated with funds wanting to rebalance their portfolios ahead of the year-end.