Russell says despite lower tax receipts, reduced borrowing costs and prior year adjustments have resulted in only a modest change to the 2014/15 gilt remit, and warns that the prospect of improving economic conditions means long dated gilts and particularly index linked gilts will remain in short supply.
Russell Investments Head of LDI Solutions EMEA, David Rae says: “Year to date, tax receipts have disappointed, primarily as a result of the employment profile. While there has been lower unemployment, this has typically been lower pay ranges and part-time resulting in a lower than expected tax take. Ordinarily, the worsening fiscal position would have led to an increase in gilt issuance to meet the cash shortfall. However, recent revisions to the historical Central Government Net Cash Requirement published in October have actually eliminated the need for extra gilt issuance this fiscal year.
“The DMO have a further GBP 9.152bn of index linked gilts to issue this fiscal year, of which GBP 5.5bn will be by auction and GBP 3.6bn by syndication sales. The next supply of index linked gilts is the auction of 0¾% Index Linked Treasury Gilt 2034 planned for 11 December. This year issuance has been roughly equally split between short, medium, long conventional gilts and index linked gilts. We can expect a similar proportional allocation in future years. The higher proportional allocation of index linked gilts in recent years has been welcomed by pension funds.
“Conditions remain challenging for pension funds looking to reduce deficits and funding level volatility. Long dated gilts and particularly index linked gilts remain in short supply. With the prospect of improving economic and fiscal conditions, this is unlikely to change in the near term. A strategy that relies exclusively or very heavily on rising yields to recover deficits is unlikely to be successful. We do expect interest rates to increase from here and we are slightly under-hedged in response. However, the extent of this under-hedging is modest in the context of the overall risk allocation, and we are closely watching opportunities to dynamically manage hedge ratios.”