UK gilts: After 30 years of calm, pension funds now must adapt to volatility
After 30 years of calm, firms have little if any institutional memory of more volatile times. But amid rising gilts, that now needs to change, writes Gus Sekhon
With the yields in 10-year and 30-year gilts reaching highs not seen in decades, there are some drawing parallels to the debt crisis of 1976. Is anyone familiar with the fraught period Chancellor Denis Healey turned to the IMF for a bailout?
Now as then, markets are nervous of the UK government’s ability to follow through with its proposed budget amid rising borrowing costs. While pension fund managers don’t expect another Liz Truss style LDI crisis, yields are higher now than in the Autumn of 2022.
Investors for a generation have taken for granted that gilt prices go up and yields down. The recent moves in yields could be another blip – albeit a large one – on this trend but equally, could be the start of a new paradigm. One where sticky inflation and elevated government borrowing keep yields above the historical norms of the last three decades.
If that’s true, the 30-year bull market is over. But what does that mean for bond trading desks and portfolio managers?
Bonds serve as the bedrock of a pension fund, but the typical fixed income portfolio often contains swap hedges, FX forwards and other complex instruments. These instruments and their combination all contain risks. The end of low stable rates means increased risk in all of these instruments in isolation and in combination. Portfolio managers now need to be alive to risks they may have simply ignored, or thought were accounted for in more stable times. If volatility was represented by geothermal activity underneath your well managed portfolio that would make unmanaged risk akin to new geysers erupting unexpectedly.
Right now, we are entering a period of frequent and unexpected eruptions – think Yosemite geysers level. Risk that was previously considered to be managed is now a significant factor impacting performance. Understanding that risk quickly is of paramount importance.
Understanding, measuring and managing this risk requires certainty, making good data more important than ever. Fund managers need to combine the disparate data streams that flow onto their desk. Information from market feeds, custodians, models and counterparties will all need to be turned into a unified data set.
It will not be easy. After a 30-year bull run, firms have little, if any institutional memory of more volatile times in fixed income. But adaption must be rapid and the data needs to be trustworthy. With the right foundations, they need not fear volatility. Mastering the data question should give portfolio managers a decisive edge in an era of declining performance fees. They can turn volatility away from an unpredictable geyser landscape to a more manageable and harnessed Yellowstone Old Faithful.
Gus Sekhon is head of product at Finbourne Technology and sat on the inflation and rates trading desk at RBS, J.P Morgan and Barclays for more than two decades