NYSE LIFFE Launches 30-Year Gilt Future in UK

Russell Investments has heralded the arrival of NYSE LIFFE’s latest security as “good news” for investors seeking liquid exchange-traded, long-dated interest rate derivatives.

(November 26, 2013) — NYSE LIFFE, the European derivatives business of NYSE Euronext, has launched a 30-year UK gilt future, following demand from the UK pensions sector.

Speaking earlier this month about the launch, Finbarr Hutcheson, CEO of NYSE Liffe, said: “As international interest in UK debt has continued to grow, we have seen strong volume growth in our 10-year long gilt futures. This, combined with the long maturity profile of much UK debt, has led to market demand for 30-year ultra-long gilt futures.

David Rae, head of liability-driven investment solutions at Russell Investments, welcomed the new ultra-long gilt future as “good news for pension schemes and investors looking for liquid exchange traded long-dated interest rate derivatives”.

Currently the only liquid UK gilt future is on the 10-year gilt, which is a relatively poor match for pension scheme liabilities, he said.

For more stories like this, sign up for the CIO Alert newsletter. 

Alternatively, interest rate swaps have been used to gain exposure, but they come with a burden of documentation and the other challenges of an over-the-counter traded instrument.

“There are a number of potential applications for this new futures contract for pension scheme investors,” said Rae.

“The flexibility of an exchange traded instrument would be very helpful to make duration and curve adjustments in a liability hedging portfolio.”

He added that NYSE LIFFE’s new instrument would also provide much needed improvement in designing hedges and efficient strategies during transitions and portfolio restructures, particularly around LDI assignments.

“We’ve recently worked with a client in the final throws of moving to a buy-out solution,” Rae continued.

“A 30-year instrument would have been a real help in hedging the buyout premium more closely with a highly liquid instrument that could be easily transferred to the insurance provider.”

30-year futures already have precedent in the US and German markets, with ultra long-duration Bunds and US Treasuries already available. While these are less liquid than the 10-year instruments, they have still proved popular with pension funds.

“As with all new futures launches, the big question is whether open interest, trade volume, and liquidity will increase sufficiently to make this a viable instrument for institutional investors,” noted Rae.

“There are some attractive features of this new launch, including the liquidity of the underlying bonds, the level of government issuance and the active investor demand that gives me some hope that this launch will be a success.

“However, there are no guarantees of success, this definitely joins the list of ones to watch and I’ll be keeping a close eye on progress.”

Long-dated gilts have endured a bumpy ride over the past year. Last month, UK gilt prices rose, pushing 10-year yields to the lowest level since August, after a US report showed American employers added fewer workers than economists forecast, boosting demand for “safer” assets.

Other factors depressing yields include the UK base rate being stuck at 0.5% since March 2009, the £275 billion of gilt purchases announced by Bank of England, austerity measures leading to reduced supply from Treasury, renewed Eurozone fears creating a move to better quality assets, the relative safe-haven status of UK as triple-A credit rating maintained, and increased regulations encouraging financial institutions to hold less risky assets.

30-year gilt issuances are unusual, but not unheard of, in the UK market. They’re not even the longest ones UK investors have seen: in May 2005, the Debt Management Office (DMO) issued a 50-year maturity conventional gilt, and in June 2013 that was followed by a 55-year maturity conventional gilt.

The DMO is to sell £2.5 billion 3.25% 2044 gilts for auction on November 28. Its auction in September, saw the sale of 2044 gilts draw a disappointing bid-to-cover ratio of 1.46 and an unusually wide price tail.

The lacklustre demand was thought to have been driven by growing confidence in the equity market place, following positive news from around the world on global economy growth.

(November 26, 2013) — The future of fiduciary management lies within defined contribution (DC), according to investment consultants Psolve.

The Punter Southall Group arm believes that, while DC schemes have so far been neglected by the fiduciary management industry, it is now time for this to change.

Many investment consultants have boosted their fiduciary management resources for DC over the past year: Northern Trust added Eric Peterson to its outsourced CIO function to work across defined benefit, DC, and Taft Hartley plans in the US in February, and Mercer hired Liana Magner to the newly created role of US delegated DC leader in May.

The key problem is how the typical DC plan approaches its default fund, said Britt Hoffman, head of DC at Psolve.

For more stories like this, sign up for the CIO Alert newsletter. 

The typical approach has been to use a simple mixture of equities and bonds, shifting members automatically from equities into bonds and cash as retirement nears, but this—as she and many others have argued—is sub-optimal.

“In the early years there is a risk of a big paper loss, discouraging DC scheme members from making more contributions to their pension. In the later years, there is a risk of equities being sold for bonds at unfavourable prices,” Hoffman explained.

The biggest issue is the growing governance burden facing managers of DC funds, and it is here that fiduciary management will develop its market, according to Psolve.

FuturePlanner, the Finmeccanica group’s DC scheme, is one of Psolve’s clients that has taken advantage of its delegated DC service. Mike Nixon, head of pensions, said: “We were being told about clever new things for the DB schemes that did not cost much. Why should our DC members miss out?”

Hoffman said the key turning point was realising that it was possible to implement a DC strategy that is much more aligned with the strategies traditionally used in defined benefit funds.

“This is a big step forwards – particularly because the risk and return needs for DC and DB are really not that different,” she said.

The shift into focussing on DC comes at a time when outsourced CIO business of investment consultants is expected to grow to 18% of their total assets, according to research from Cerulli Associates.

Psolve rival Cardano also celebrated a birthday this month, and marked its fifth anniversary by publishing the fiduciary management results of its clients. The fiduciary manager’s clients outperformed their peers on a liability base by 30 percentage points.

There is scant data on the performance of fiduciary managers and other outsourced providers. Pick up the December European edition of aiCIO for a full investigation into inadequacies of the market.