The UK Debt Management Office has put a brave face on the disappointing response to its issue of 50-year gilts in mid-July. The DMO, in its second sale of these ultra-long bonds, sold £2.25 billion worth; but the sale drew bids of just 1.23 times the amount on offer, the smallest cover for any conventional gilt auction since the creation of the DMO in 1998. The DMO reintroduced the 50-year gilt in May after a break of more than 40 years. The result was particularly surprising in the light of the supposedly enormous gap between the supply of long-dated assets and the demand for them. Changes to pension fund regulation in Europe – Spain is the latest in a growing line of reformers – as well as increased pensioner longevity are forcing trustees to look hard at their asset/liability matching. In addition, there is a growing belief that the last 30 to 40 years, in which inflation has been high by historical standards and equities have been the logical asset in which to invest, have been some kind of blip.
Arnaud Marès, head of portfolio strategy at the DMO – and his equally French counterpart Benoît Cœuré at the Agence France Trésor – both point out that perpetuals were a plank of government issuance in both countries for most of the 19th century. The implication is that we are heading back to a lower growth, lower inflation environment in which the actuarial profession’s methodology of discounting long liabilities with equity returns has no clothes.
So with half a trillion dollars waiting to be re-allocated in Dutch funds alone, why did the auction do so badly? One answer is that these bonds still don’t have long enough duration to hedge the 30-year liabilities pension funds can face. Another is that nominal bonds of this maturity have, throughout the blip, proved disastrous stores of real value – and it is real yield, not simply matching, that investors need. In any case, many investors thought that if they waited they could buy this issue more cheaply later.
Most worrying though is the thought that the real reason for the failure is that, as usual, trustees still have not woken up to changes in their environment and are waiting for their consultants and committees to tell them what to do. As with derivatives, structured products and alternative investments, this delay will cost pensioners – present and future – dear.
There is a bigger issue on the horizon though: right now, governments and their debt offices are not working together to help solve a problem that governments have created. The issuance vehicles do not have a mandate to supply at any cost the kinds of securities required by the wider market, even if that demand is the result of government policy. They issue where they think they can get the cheapest money in the medium term, and they issue only enough to meet government funding requirements.
What the market needs is billions of dollars’ worth of long-dated, inflation-linked securities at a time when governments want less debt and would be foolish to issue linkers – it’s the bottom of the inflation cycle. But without co-ordinated policy and issuance, the private pension sector will be destabilized further. And that is good for no one.
