Inflation-linked bonds offer one way of mitigating the inflation risk in pension scheme liabilities; however, this market also provides a number of challenges. Thankfully, alternative options to protect schemes against a rise in inflation do exist.
In a recent paper, we provide analysis on these key points:
Inflation-linked bond markets have expanded
Inflation-linked outstanding issuance has quadrupled since 2005. Inflation-linked bonds in issuance amount to £235bn, with roughly £200bn in inflation-linked gilts and £35bn of corporate issuance. The liquidity on the long-end has improved.
But not enough to match pension schemes’ appetite
This should be great news for pension schemes as they establish de-risking strategies and seek matching assets. However, the inflation-linked market growth is not enough to match the inflation-linked part of the £1,200bn UK pension schemes’ liabilities. This mismatch between demand and supply is not likely to revert soon, pushing the real yield at the long-end lower.
Alternative sources of inflation-linked assets
In order to avoid this shortage of supply, pension schemes should compare index-linked gilt opportunities to other solutions available in the Liability Driven Investment space. There are often other ways to hedge inflation risk at a lower cost and still benefit from credit and illiquidity premia.
To read the full paper, click here.
[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice. Click here for full disclaimer]