The cost for UK pension schemes of hedging liabilities is greater than ever because demand for government bonds, or gilts, is being kept high by quantitative easing as well as regulations that push institutional investors to buy such bonds, asset managers have warned.
“Pension funds only own about a third of the gilt market and compete for supply with insurance companies and other financial institutions, overseas buyers, individuals and now the Bank of England,” said John Stannard, head of consulting for Europe, Middle East and Africa at Russell Investment.
“So, today the cost of hedging liabilities is at an all-time high. Derivatives can help supply levels, but prices are driven by gilts prices and are expensive at the long end.”
Some industry figures are worried government bond prices are unsustainable and are due for a correction that could challenge scheme’s funding levels.
“Governments have, perhaps unwittingly, created a new bubble in asset markets, namely in sovereign bonds,” said Liad Meidar, managing partner at Gatemore Capital Management.
“If we are in a bubble, when will it burst? Timing is always uncertain, but it is clear that the mark-to-market repercussions will be immense – and many or even most pension schemes may miss the single biggest opportunity in recent history to dramatically improve their funding levels.”
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