UK Budget introduces 50-year bonds
Pension funds will see an immediate benefit from the introduction of 50-year bonds by the UK government from next month.
The ultra-long bonds are expected to help pension schemes better match their liabilities and help set the price of the synthetic products being expensively sold by investment banks.
Gordon Brown, the Chancellor of the Exchequer, in the Budget on Wednesday said: “We will now issue long-term bonds with maturities for the first time in a generation of up to 50 years.”
The Debt Management Office, which issues the gilts, said it planned to auction off an as-yet-undisclosed amount of the 50-year bonds as part of the £53.5bn (€76.8bn) of debt being raised in the next financial year starting on 1 April.
The ultra-long bonds will form part of the £18.5bn in long-dated and £11bn index-linked gilt issuance. The UK’s move follows 50-year bond issuance by the French government and Italian phone giant Telecom Italia.
Tim Keogh, worldwide partner at Mercer Human Resources Consulting, said the 50-year bond issuance would help match liabilities. He added: “It will become easier for pension funds in wind up to terminate a plan and buy annuities. For schemes that are continuing it will reduce risks, particularly if it is the index-linked gilts, as this is where the shortage is most acute.”
UK retailer Boots's pension fund made a well-publicised move wholly into bonds in 2000 but decided last year to move partially back into equities partly because the 30-year bonds were not an exact match to its liabilities or the risk that employees would live longer.
Stephen Yeo, partner at Watson Wyatt, agreed with Mr Keogh that the planned issuance would not materially affect deficits but would help pension funds match their liabilities more closely.
As the price of the ultra-long gilts had not yet been set, Mr Yeo said it was too early to say if it would affect pension fund deficits. If demand was too high it would force the yield down and thereby potentially increase the deficit from forcing funds to discount their liabilities at a lower rate.
But Denis Gould, head of UK fixed income at Axa Investment Managers, warned demand for the bonds could be fleeting. He said: "Interest in issuing 50 year bonds has taken off dramatically since the UK Debt Management Office began consulting about the possibility of issuing 50 year gilts.
"For the future there is clearly demand for ultra-long maturities, especially from liability driven investors. However we think the current craze for 50 years may wane. In government bonds 50-year issues have the benefit of higher convexity which is worth something, but investors receive next to no extra yield for moving out to a rather isolated point on the curve where liquidity could be poor. Worse, if other countries decided to follow France's lead an issue 50-year bonds, demand could quite quickly become exhausted.”
Jeremy Toner, fixed income portfolio manager at Investec Asset Management, agreed and warned: “ Large institutions wanting to match very long-term liabilities are likely to lock these bonds away, turning them very quickly into a highly illiquid addition to the yield curve. More importantly, while governments are showing an astute understanding of timing by issuing very long dated instruments when inflation and interest rates are particularly low, investors face the risk of capital losses unless the bonds are priced with the potential for higher future inflation.”
Also in the Budget, the Chancellor said the Treasury would spend £4m promoting a cheap pension from the Stakeholder range of simple, low-cost savings and investment products that start in April. John Pollock, a group director at Legal & General, a UK insurer, welcomed the move and said: “We are delighted the government has recognised the need to broaden the appeal of the Stakeholder suite to help stimulate the long-term savings market.”