£450bn of UK pension funds’ inflation-linked liabilities remain unmatched
£450bn of inflation‐linked liabilities belonging to UK pension funds remain unmatched, according to new data shared with Morning Wire this afternoon.
As higher inflation risks currently prevail means demand for inflation-linked assets continues, yet there is a lack of supply of such assets, according to Alpha Real Capital
The firm’s analysis suggests the value of private sector UK defined benefit fund liabilities is around £2.2 trillion, of which approximately £1.5 trillion is inflation‐linked.
There are only around £800bn of index-linked gilts, which suggests a shortfall of £700bn. However, as many schemes use so-called Liability Driven Investment techniques, the portion of inflation‐linked liabilities is around 70 per cent, or £1.05 trillion, which leaves around £450bn of unmatched inflation-linked liabilities, the firm explained.
Moreover, there are not enough long dated index-linked gilts available to enable pension schemes to match their longer‐term liabilities, the firm stressed.
Index-linked gilts
Analysis of the current supply of index‐linked gilts reveals that out of 31, only 14 have a maturity of more than 20 years and only three of these have a maturity greater than 40 years, representing only approximately 14 per cent of the total market value of index‐linked gilts.
The longest dated gilt ‐ maturing in 2068 ‐ was introduced in 2013. 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, Alpha said.
Adding to heightened inflation fears, schemes are moving closer to their endgame faster than expected. Funding levels have fared well, and in many cases, actually improved through the pandemic as a result of the strong performance of risk assets. This means that pension funds not
only want to de‐risk but many more can afford to do so, which means demand for inflation-linked assets remains high. The certainty given by the recent RPI reform announcements on the future of the RPI measure is another factor catalysing some pent‐up demand for inflation‐linked assets.
“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,” said Shajahan Alam, director of CDI Alpha Real Capital.
Alam told Morning Wire that, 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 per cent to as low as 5 per cent 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,” he concluded.