Schemes paying ‘outrageous premium’ to match liabilities

Pension schemes are missing the “biggest opportunity in recent history” to improve their funding levels by continuing to buy sovereign bonds, Gatemore Capital Management warns.

The firms said a bond asset bubble - created by government purchases and pension regulation pushing more schemes to buy bonds - means pension fund trustees are paying an "outrageous premium" to match liabilities.

Nominal gilt yields are currently hovering at 2% with real yields in negative territory - but schemes are still ploughing into the asset class.

Gatemore Capital Management managing partner Liad Meidar said: "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."

The firm said two forces are at work squeezing pension funds' bond strategies.

Pension regulation push institutions to own more bonds to hedge liabilities and take less risk and at the same time the Bank of England's quantitative easing monetary policy has turned central banks into one largest buyers of bonds.

The bank now owns one-third of the gilt market, warping pricing. If bond yields spike it could lead to schemes having locked in asset prices at a much lower level leading to funding difficulties.

"Bond investors are either betting that Western economies will head down the same path as Japan did twenty years ago or they are paying an outrageous premium to ‘match' their liabilities," Meidar added.