Pension schemes have ‘learned key lessons’ from 2022 as yields rise

Persistent inflation and concerns about economic growth have led to a sell-off in government bonds globally, with yields rising in several countries including the US, France and Germany.

In the UK, the yield on the 10-year gilt hit 4.93% on Thursday (9 January), the highest it had been since 2008 at the peak of the global financial crisis.

Concerns about the government’s spending plans have also hit the government bond market, exacerbating the sell-off, analysts have said. Similar concerns about the fiscal plans of the incoming Trump administration in the US have also driven US Treasury bond yields higher.

Lessons learned from 2022 gilts crisis

However, several commentators have highlighted that pension schemes are more robust against yield volatility than they may have been in 2022, when gilts sold off dramatically in the wake of the Liz Truss-led government’s ‘mini-Budget’.

Martin Shimell, a senior investment manager, said: “Pension funds experienced the ultimate stress test to their resilience through the 2022 gilts crisis and subsequently the industry and regulators have adapted and learned the key lessons of that crisis…

“The gilts crisis of 2022 was self-reinforcing to a degree and greater resilience in the liability-driven investment (LDI) market together with the track record of the Bank of England in support of the gilt market should help stave off the sequel.”

David Brooks, head of policy at Broadstone, said: “LDI funds have been actively managing their cash positions in response to this shifting investor sentiment and market volatility, but there don’t seem be any systemic issues at play.

“Improvements to collateral management and waterfall structures since the 2022 yield crisis have significantly strengthened market resilience and ensured schemes are better prepared to handle fluctuations.”

While scheme sponsors and trustees may be concerned by the gilts sell-off, TPT’s Shimell said, for many pension schemes the developments will mean “improved funding levels and opportunities to lock in incremental gains through de-risking programmes”.

The funding levels of defined benefit schemes have improved markedly since 2022 as rising yields have led to reductions in liabilities, which have typically outweighed asset price falls.

Don’t get complacent, trustees urged

For those pension schemes with LDI strategies, which use gilts as collateral for borrowing, Shimell said trustees should “check in” with advisers to assess their collateral and liquidity positions and “stand ready for accelerated decision-making”.

“Liquid assets may need to be sold in some cases to maintain hedges and protect funding positions from a possible reversal in yields,” he explained. 

Matt Tickle, chief investment officer at Barnett Waddingham, added: “Given the global movements and pace of the shift, we do not believe the current situation is akin to that experienced in September 2022…

“However, we do not believe schemes should be complacent. We recommend schemes review their collateral adequacy and ensure they can withstand further yield rises from their current, elevated, levels.”

Broadstone’s Brooks recommended that, as well as monitoring hedging and collateral positions, trustees and sponsors should look at opportunities to rebalance investment portfolios or make progress on derisking strategies.

“In addition, trustees may need to review commutation factors to ensure fair value and potentially review covenant positions where sponsor’s borrowing costs have risen,” he added.

Government bond market outlook

Barnett Waddingham’s Tickle said the recent yield movements were “an overreaction to global political uncertainty”.

“Although global fundamentals have shifted towards a more inflationary environment, the UK economy has relatively weak growth prospects and interest rates are still set to fall,” he said.

“Markets still expect two rate cuts from the US Federal Reserve and Bank of England over 2025, a position largely unchanged over the past month despite the significant yield rises.”

Tickle said he expected gilt yields would fall back over the course of 2025 and 2026 as the Bank of England loosens monetary policy, eventually reflecting lower economic growth and lower inflation.

However, he added that inflation was likely to “remain stubbornly above the 2% target in both the short-term and medium-term and so rate cuts may well be pushed to later in 2025 and into 2026”.

“The uncertainty set out above is not suddenly going to be resolved and so this could well leave gilt yields at an elevated, and volatile, level over the early part of 2025,” he said.

In a blog post on Thursday, Dillon Lancaster, a portfolio manager at TwentyFour Asset Management, said the recent market movements could have been influenced by poor economic growth data in the last few months of 2024, which has made the Office of Budget Responsibility’s 2% growth forecast for this year look “optimistic”.

Lancaster also pointed to technical factors, including a block of £2bn worth of gilts that was tendered on Wednesday morning (8 January), which may have shifted the overall price.

In addition, he said some investors may have been watching for the 10-year gilt yield to hit 4.75%, its most recent peak. Once it hit this level it may have triggered the unwinding of some positions, meaning the sell-off “took on its own momentum”.

Looking ahead, Lancaster said gilts were most likely to trade in line with US Treasury bonds, so may be influenced as much by US data and the policies of the incoming Trump administration as by UK policy.

Further reading

Budget 2024: Bond managers downplay gilt market volatility (31 October 2024)

What the next gilts market shock could look like (2 December 2024)