A long-dated index-linked Gilt auction from the UK government was significantly oversubscribed as pension funds come to terms with negative yields and hedge inflation risk.
This is expected to be the last significant auction before May’s general election, with demand afterwards expected to drop in line with government plans to reduce debt issuance.
This week’s offering from the UK Debt Management Office (DMO) saw a £4.6bn (€6.1bn) auction of index-linked 2058 maturity bonds fetch £16.8bn in commitments, despite a negative real yield of 0.9%.
This is not the first time yields have reached this low, with 10 and 20-year-duration bonds providing a nominal yield on negative 0.7%.
However, the commitment to auction amount ratio (bid to cover) of 3.65 was significantly higher than any seen in the index space, long-dated or otherwise, within the last year.
A 2050 index-linked Gilt auction last November fetched a nominal yield of negative 0.39% and a bid to cover ratio of 2.11.
Head of solutions research at AXA Investment Managers, Shajahan Alam, said the lion’s share of the auction would have gone to “real money” investors, with pension funds accounting for a large chunk of that.
“The big picture is the liquidity in the market and the demand from investors,” he said.
“It has dropped below negative 1% for some long-dated linkers, but the markets have been difficult to read over the last quarter and understand what is going on.”
He said the surge in demand for the last significant long-dated auction for some months was somewhat tempered by the negative yield, but, going further forward, the issuance would be below the circa £30bn seen in this financial year.
AXA IM said there were pension funds waiting to invest in index-linked Gilts but that many operated trigger-based hedging and would enter the market when real yields reached a certain level.
“These triggers are unlikely to be reached, so they need to be revised down, or investors need to capitulate and hedge as opportunities arise,” Alam said.
“There is a wall of demand from these funds deciding to hedge, and this auction is a turning point, where we are seeing investors who did not previously believe yields would get this negative throwing in the towel.
“It shows a willingness [from investors] to do this, and we see this playing out over the next year, and, given the lack of supply, we cannot see how yields will rise significantly.”
He also warned of the upcoming Gilt benchmark restructuring expected to occur by 16 April, which could see liquidity adjustments in Gilt markets.
From April, 2020 index-linked Gilts will fall out of the FTSE A five-year index, an index widely used among investment funds.
The index carries around £24bn in issuance, and the dropping of the 2020 Gilt will see fund managers readjusting their funds to account for duration loss.
“At the very least, we expect around £2bn will need to be automatically switched into the revised index, and it is likely further substantial demand will be generated from funds actively managed [against the index],” Alam said.
“This will provide further support to yields – unless the DMO acts to absorb through issuance activity very early in the Q2 this year.”
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