MNI: UK Infrastructure Drive Risks Sapping Demand For Gilts

The UK government's drive to direct more pension fund money towards infrastructure risks further squeezing already soft long-dated gilt demand, leading to a structural shift higher in yields unless increased investment boosts economic growth, former government minister Jim O'Neill and other experts told MNI.

The government’s proposed Edinburgh financial sector reforms include measures to encourage pension funds to invest more in illiquid assets including UK infrastructure, as part of the “levelling up” agenda to support less well-off parts of the country. But this move away from encouraging funds to match liabilities with safe investments in bonds risks reinforcing weaker structural demand for long-dated gilts, for which pension funds are the dominant buyers.

“By definition, unless their assets rise if they start to buy more productive assets then others will be bought less,” O’Neill, a former Commercial Secretary to the Treasury and Goldman Sachs division head who has championed the government’s Northern Powerhouse project, told MNI.

The sums held in UK private sector pensions are vast, with the Pensions Policy Institute estimating GBP1.67 trillion in defined benefit schemes and GBP545 billion in defined contribution schemes.

"Who is going to buy the long-dated gilts if pension schemes are selling them off is a real concern," said the PPI’s Lauren Wilkinson.

UNCERTAIN DEMAND

While Wilkinson noted it was possible the more conservative DC schemes could step in as long-dated gilts buyers as DB schemes shift towards alternative, less liquid investment including infrastructure, she said this not certain.

"I am not sure that the appetite is really there for it. I am unsure who the large-scale buyers would be," she said.

In 2022, DC retirement point schemes allocated roughly 60% to bonds, of which gilts make up around 20%, PPI data shows. On the DB side total allocation to bonds was 71.6% of portfolios.

The Debt Management Office's latest gilt remit, published following the spring budget, already revealed a reduced share of longer-dated bonds, with DMO head Robert Stheeman telling MNI that there had been a structural shift away from them as the duration of the pension industry’s liabilities has reduced. (See MNI INTERVIEW: UK Long-End Gilt Market Functioning Better- DMO)

Encouraging funds to enhance infrastructure investment only risks solidifying this trend, potentially forcing the government to borrow more at shorter parts of the curve.

However O’Neill argues that more infrastructure spending should boost UK growth and potential supply, easing the squeeze on yields.

“There would be almost definitely an asset allocation away from gilts to productive assets but if the UK valuation of its equity and related markets rose this would be good news. And if it played a role in boosting stronger investment and growth it would lead to … less gilt supply,” he stated.

FIDUCIARY DUTY

The government’s planned reforms would see modifications to rules on pension funds’ performance-related fees in order to make infrastructure more attractive. But Wilkinson noted that this would favour potential investments overseas just as much as those in the UK.

"At the moment it's very much that they can choose to invest in infrastructure anywhere and there is no incentive to invest specifically in UK infrastructure," Wilkinson said.

At the same time, if the government were to push harder to get funds to either invest minimum amounts in infrastructure or to proscribe where they can invest it could end up clashing with the basic duties of the pension providers.

"Pension fund trustees have fiduciary duties to their members so I am not sure how far the government can go before it really does come up against a hard conflict with that," Wilkinson said.