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'Record demand' for index-linked Gilts stems from pension duration gap

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A UK Gilt issuance that attracted £14.5bn (€18.3bn) in offers is proof that pension investors are keen to address their duration mismatches in their hedging profiles, despite falling bond yields.

Following the syndication of £5bn in 45-year index-linked Gilts, AXA Investment Managers (AXA IM) said interest, which stood at £14.5bn, proved there was still significant demand for such issuances, despite a negative yield of 5.3 basis points a year.

Lucy Barron, senior solutions manager at AXA IM, said the demand clearly stemmed from domestic pension providers wishing to manage liability risk.

“Index-linked Gilts continue to be seen as the best match to inflation-linked liabilities,” she said.

“However, with circa £400bn of index-linked Gilts in issue versus around £1trn of inflation-linked pension liabilities, the supply and demand imbalance is unlikely to be eased any time soon.”

The issuance, which matures in 2058, will grant many institutions the ability to address both duration and maturity gaps in their existing hedging portfolios, according to Barron.

“In addition, the significant supply at the syndication has highlighted hedging opportunities for pensions schemes that have flexible LDI mandates in place to take advantage of the current attractive pricing for hedging inflation risk separately to interest rate risk,” she said.

“The cost of hedging long-dated inflation risk using either inflation swaps or index-linked Gilts with their interest rate sensitivity removed is at the most attractive level in over a year.”

The comparatively low volume of index-linked Gilts, when viewed against pension liabilities, has caused the UK National Association of Pension Funds to warn that it was “creating risks” for pension funds.

“There has been increasing frustration from schemes that, to reduce their interest rate and inflation risks, they are effectively ‘forced’ buyers of Gilts with low or negative real yields,” the association said in June.

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