Index-linked gilt shortfall to worsen as funding improves

The real assets manager said the strong performance of risk assets over the past 12 months has led to many schemes seeing an improvement in funding levels and looking to de-risk further.

Research by the investment manager found a majority of UK schemes now fear that higher levels of inflation may persist in the longer term and many said they expected to increase their level of inflation hedging.

Yet, Alpha's analysis found there are not enough long dated index-linked gilts available to enable pension schemes to match their longer‐term liabilities.

It said that, of the current supply of index‐linked gilts, only 14 out of 31 have a maturity of more than 20 years and only three have a maturity greater than 40 years, representing just 14% of the total market value of index‐linked gilts.

The firm said the longest dated gilt, which matures in 2068, was introduced in 2013 - noting that, with no extensions in maturity for nearly a decade and relatively low issuance at the long end, the duration of the index‐linked gilt portfolio has fallen markedly.

It added the proportion of index-linked gilts issued as a proportion of total issuance has also fallen substantially. Alongside the Budget last month, the Debt Management Office slashed the number of planned gilt sales for 2021/22, reducing the total issuance by £57.8bn to £194.8bn, and causing a drop in yields.

Alpha Real Capital director of cashflow-driven investment Shajahan Alam said: "Despite the high level of gilt issuance practically every year since the financial crisis - with a truly record breaking £486bn raised in 2020/21 as the government needed to finance the fight against the pandemic - there remains a shortfall of index‐linked gilts.

"While the absolute levels of index‐linked gilts issuance have been high at an average of around £30bn a year since the financial crisis, the proportion of total issuance that is index‐linked has fallen dramatically from a high of 25% to as low as 5% more recently. So, while the government's financing needs are expected to remain elevated, the supply of index-linked gilts is unlikely to satisfy demand."

Alpha Real Capital chief investment officer Edward Palmer added: "Our analysis comes at a time of growing concern amongst pension schemes about rising inflation. Our research suggests that over 70% of UK pension schemes see a moderate or high risk that higher levels of inflation may persist in the longer term and over half of the respondents also said they planned to increase their level of inflation hedging. They may find this increasingly difficult."