The yield for a 30-year gilt reached a high of 5.7% in early September – higher than during the gilts panic of 2022. Why is there not a similar meltdown now, and what should trustees be doing to remain prepared for all eventualities?

In September 2022, gilt yields spiked, precipitating a downward spiral for pension funds with liability-driven investments – which was only stopped when the Bank of England stepped in as a buyer of last resort. Some defined benefit schemes emerged from that episode in better shape than before, but a few got badly bruised.

Three years later, 30-year gilt yields are now higher than they were just after the fateful mini-Budget of Liz Truss and Kwasi Kwarteng, peaking at 5.7% on 2 September this year. At the height of the mini-Budget crisis of 2022, the 30-year gilt closed at 5%.

The issue was raised in the Lords Chamber at the start of the month. Financial secretary to the Treasury Lord Livermore attributed the high yields to undefined “global factors”, pointing out that other nations have also seen yields rise.

However, the government is clearly concerned about yields, given its need to borrow significantly. Chancellor Rachel Reeves met with Gilt-edged Market Makers on Monday to discuss views on global and UK economic prospects as part of her twice-yearly engagement, indicating that she was in “listening mode”. 

For Yona Chesner, head of investment-north at Cartwright Pension Trusts, the 2022 gilts panic was less about the absolute level of gilts than it was about pension schemes not having been prepared to recapitalise their leveraged positions as yields rose sharply, “coupled with a widespread belief that gilt yields would continue their long-term downward trend”. 

 

The 2022 crisis has also been a lesson for regulators as much as for investors and managers, who have largely deleveraged and stress-tested collateral buffers, so that systemic vulnerability is lower, Chesner thinks.  

 

“The current high level of gilt yields actually makes a lot more sense than the – arguably artificial – low levels they saw until 2022,” he said. 

 

Chesner attributes this to the Bank of England no longer acting as a backstop buyer in unlimited quantities, the fact DB schemes have bought all they need “and are arguably net sellers for the foreseeable future as they continue to offload their assets and liabilities to insurance providers”, and said that a market belief that loose monetary policy will not lead to inflation surges has been “proved wrong”. 

 

In addition, “the government's fiscal woes don't appear to have any imminent solutions – more borrowing is to be expected, putting upward pressure on yields”, he predicts. 

 

The key for DB schemes is to plan for both eventualities, he believes: “Whether yields fall or rise, a well-prepared scheme will be largely immunised against the impacts. In particular, schemes should not only look to their sources of liquidity, but their operational capacity to deal with the situation in a timely manner should the unexpected occur.”  

 

Schemes enjoy good funding from high yields and can look to transfer to insurers, he noted, but warned this kind of environment also means annual cash requirements represent a larger portion of total assets than trustees are accustomed to, meaning some schemes will need to revisit their cashflow policies.  

Ben Johnson, senior director at WTW, echoes the view that the 2022 crisis was more about speed and operational issues, while the system is more resilient today.

This was also the finding of a recent LDI report by the Pensions Regulator, though TPR encouraged trustees to carry out periodic stress tests and potentially diversify collateral pools.

Higher yields have boosted funding levels, but Johnson agreed risks remain: “UK fiscal stress could hit gilt values and even challenge the notion of gilts as ‘risk-free.’ Buyouts aren’t immune either – high inflation could erode real benefits due to indexation caps. And with gilts offering higher returns, outperforming them elsewhere will be harder.”  

 

He advises trustees to think beyond gilts: “Don’t let the measurement tail wag the strategy dog. Valuing liabilities using gilt yields can create an artificial obligation to hold gilts, but they’re just one tool. Start with your objectives and then choose the most efficient mix of assets – assessing on their risk, return, and hedging merits.”   

Laith Khalaf, head of investment analysis at investment platform AJ Bell, said the recent rise in bond yields is not just a UK phenomenon, as the market has digested stickier inflation and a wall of bond supply from governments.  

“There are parallels here with 2022, as global yields were indeed rising throughout that year as inflation was stoked by the Russian invasion of Ukraine. However, the days immediately following the mini-Budget marked a temporary UK decoupling from the global bond market, suggesting more local factors were at play,” he said. 

In 2022, gilts across the maturity curve were selling off. Today’s impact remains concentrated at the long end and will therefore not have a big effect on mortgage holders, he noted.  

However, it does very much affect institutional investors with long-term liabilities to match. Some of them could even be the cause of recent price moves, as DB pension schemes are transferring to insurers in droves thanks to the high funding that gilt yields are creating.  

Others think the Bank of England’s programme of selling stock accumulated during the crises of the past two decades is pushing up long yields, which are strongly influenced by supply and demand compared with shorter issues. However, the Debt Management Office’s auction of £3bn in 2040 gilts on 16 September was nearly three times oversubscribed, showing appetite remains strong. A 2063 issue from June attracted even more interest.    

“At current levels and in the present circumstances, the bond market doesn’t appear unduly concerned about QT. However, as in 2022, the actions of pension funds do raise questions about the yields on long-term government bonds,” said Khalaf, pointing to pension risk transfers.    

“This does present a headwind to demand for long-dated government debt, which is also exacerbated by the government’s drive to get pension funds to invest in private assets such as smaller companies and infrastructure. If the government is successful in this drive, it will serve to lever pension schemes out of their traditional habitat of UK gilts,” he predicted. “As they say, be careful what you wish for.”