How are DB schemes changing the gilts market?

The data and analysis company claimed that the shift to defined contribution pension provision meant there would be substantially less pension demand for government bonds in the future.

Bloomberg Intelligence reported that defined benefit (DB) schemes had sold a total of £211bn worth of gilts since 2020. The overall share of the gilt market directly owned by pension schemes had fallen by 7.8 percentage points in the same period.

This was in part due to high volumes of buy-ins and buyouts, as insurers tend to allocate less to gilts than pension schemes, Bloomberg Intelligence suggested.

Insurers and pension schemes now own 24% of the gilt market, down from 65% two decades ago, according to the data company.

However, fixed income investors have questioned the data and its interpretation, highlighting several factors supporting ongoing pension scheme investment in gilts.

The role of LDI

Philip Howard, head of liability-driven investment (LDI) solutions management at Schroders, said: “The idea that pension schemes will sell all their gilts is exaggerated. It is true that, with defined benefit schemes closed and largely hedged, the UK can no longer rely on the fiscal tailwind of LDI programmes being large buyers of gilts. 

“But the Treasury knows this and we expect it to pivot gilt sales towards the shorter bonds more favoured by other investors. In 2023 we believe that UK banks, retail investors and annuity providers increased their holdings of gilts alongside the diminished but still healthy buying from pension schemes.”

Rosa Fenwick, head of core liability-driven investment (LDI) portfolio management at Columbia Threadneedle Investments, said the 20-year decline in gilt ownership noted by Bloomberg Intelligence coincided with the rise of LDI strategies. Many of these are run by fund platforms registered in Ireland or Luxembourg, meaning they are likely to be classified as foreign investment in the UK gilt market - even though UK pension schemes are ultimately the beneficial owners.

Taking this into account, Fenwick said the current ownership of gilts by UK schemes was closer to 50% of overall issuance.

Serkan Bektas, head of client solutions group at Insight Investment, also said pension schemes may be holding more gilts than it initially seems, as these assets are usually used by schemes as collateral for repo arrangements with banks.

Ensuring a strong gilt market

Bektas also pointed out that one of the aims of the government’s Mansion House reforms was to diversify the buyers of gilts and “ensure the gilt market remains strong”.

In his Mansion House speech in July last year, chancellor Jeremy Hunt cited three “golden rules” guiding the reforms, the second of which was prioritising “a strong and diversified gilt market”.

Schemes that choose to run on rather than transfer to an insurer will play a role in the continuing support of the government bond market, Insight’s Bektas added.

Bloomberg Intelligence’s £211bn figure for gilt sales clashes with figures from the Pension Protection Fund’s Purple Book, its annual report on pension scheme asset allocation and funding.

Data from the latest edition show that the market value of DB scheme gilt holdings fell by approximately £230bn between 31 March 2020 and 31 March 2023, but this was largely down to the fall in gilt prices as interest rates rose.

In a blog post last February in the wake of the gilt market turmoil of September and October 2022, Christopher Jeffery, head of inflation and rates strategy at Legal & General Investment Management, said pension schemes would still be significant buyers of gilts. He said demand of £50bn a year “seems plausible” when factoring hedging activity and asset allocation changes.

A recent survey of trustees by the Pensions Management Institute and Schroders Solutions found that higher interest rates were pushing schemes towards fixed income investments as part of their end-game solutions.

Roughly half of respondents said their scheme was looking towards a ‘low dependency’ approach rather than transferring to an insurer, implying that they could be long-term investors in fixed income. In addition, 29% said they were planning to make greater use of LDI strategies.

Lastly, while the bulk annuity market is expected to experience annual volumes of approximately £50bn a year over the next few years, private sector DB schemes have an estimated £1.4trn in assets, meaning gilt demand is likely to remain strong for the foreseeable future.