UK defined benefit pension schemes are facing an estimated £450bn hole in their balance sheets due to a shortage of long-dated inflation-linked gilts, according to a new analysis.
Up to £450bn worth of inflation-linked liabilities are in jeopardy because the government hasn’t issued enough index-linked debt for pension schemes to match them, according to an analysis by Alpha Real Capital (ARC).
This is despite the fact that the government raised a record £486bn raised in last year to finance the fight against the pandemic.
Although the absolute levels of index-linked gilts issues has remained high at an average of £30bn a year since the 2008 financial crisis, the proportion of these that are inflation-linked has plummeted from 25 per cent to as low as 5 per cent more recently.
“While the Government’s financing needs are expected to remain elevated, the supply of index- linked gilts is unlikely to satisfy demand,” said Shajahan Alam, a director at ARC.
Out of this current supply of 31 index‐linked gilts, 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 analysis reveals.
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,” ARC warns.
And the mismatch could be exacerbated as inflation increases and schemes move towards their endgame faster than expected.
Meanwhile, the demand for inflation-linked assets remains high as many pension funds want to de-risk after their funding levels weathered the pandemic well, improving as a result of the strong performance of risk assets.
The research also suggests that over 70 per cent of UK pension schemes think there’s a moderate to high risk that higher levels of inflation may persist in the longer term, while over half plan to increase their level of inflation hedging – which analysts at ARC warned they may find “increasingly difficult” due to the mismatch.