Ultra-long gilts are under pension scheme scrutiny

Overall demand from pension schemes and insurers has reduced, pushing 30-year gilt yields to levels not seen since 1998. Yet the absence of ultra-long gilt issuance has created a supply imbalance, fuelling atypical yield behaviour.  

Bond-pricing anomaly 

Notably, the 2073 gilt is yielding significantly less than the 30-year gilt– a record level of inversion. 

This bond-pricing anomaly is shaped by hedging constraints inherent in liability-driven investment (LDI) strategies, as it forms the final point on the gilt curve.  A re-evaluation of discounting methodologies, such as adopting truncated curves like those used by the BoE, may  ease pricing tension and enhance valuation metrics.

The case for an ultra-long gilt market 

Pension schemes rely on long-dated gilts to hedge interest rate exposure under LDI strategies. Responding to this structural demand, the UK’s Debt Management Office (DMO) issued the 50-year 2073 gilt, extending UK gilt maturity profiles beyond those of most other developed economies.   

LDI mandates aim to hedge mark-to-market volatility in liability valuations caused by shifts in interest rates and inflation. The chart below illustrates a typical ‘investible’ liability profile alongside a matched gilt portfolio. Fund managers seek to mirror aggregate interest rate sensitivity while maintaining coverage across varying maturities. 

As the last liquid point on the gilt curve, the 2073 gilt plays a pivotal role – serving as the hedging instrument for the final point of the liability profile. However, recent developments have raised concerns around this section of the market. 

Source: Aberdeen, 30 April 2025

Reason for concern?

Although base rates have dropped 5 times since the second half of 2024, long-dated gilt yields remain stubbornly high. This is a normal pattern driven by term premia, where investors demand higher returns for longer lending periods. 

However, the 50-year zero coupon gilt rate breaks this pattern and trades nearly 1% lower than the 30-year rate, reversing standard yield logic. While curve inversion has long been a feature of the UK market, the current distortion exceeds historic norms, having widened from historic levels of 0.2%. 

Source: Aberdeen, 30 April 2025

Why are investors comfortable with a lower yield for these longer-dated papers? 

Ongoing issuance of long-dated gilts has driven up yields, particularly at the 30-year maturity. Yet the 50-year point is an exception. As the only instrument available to hedge 50-year liabilities its demand remains high, but any increases in supply of the 2073 have been of minimal size. 

With no viable substitutes at the ultra-long end, investors are effectively price agnostic – compelled to buy the 2073 regardless of its yield level.  

Could a change in valuation approach reduce reliance on ultra-long gilts? 

Determining the asset strategy is the final stage in a multi-step process in LDI solutions. Assumptions are made at each stage of this process and a key question is which gilt curve to use to discount the liabilities, particularly when creating an investible liability benchmark. 

Source: Aberdeen, 30 April 2025

Using a market-based framework to value liability risk is important and would typically be the most common approach. However, when part of this yield curve is exhibiting illiquid pricing features, there can be an impact on results. 

The regulator has dealt with similar issues by moving away from market-based inputs to some arbitrary data assumed to be aligned with long-term neutral rates. EIOPA, the EU agency supervising insurers, has come up with the notion of the ultimate forward point when valuation would converge into a non-market yield. And closer to home, the Bank of England is creating its own set of curves with a maximum maturity of 40-years. 

Perhaps pension schemes could follow a similar approach.  For example, when creating the investible benchmark schemes could value their liabilities using a yield curve which has a final liquid point at 40 years, as shown in the chart below. This approach could bring more flexibility and allow re-allocation to the more liquid 30/40 year gilts in the market.

Source: Aberdeen, 30 April 2025

The potential impact is very limited, as illustrated in the table below. However, this may be a way of limiting further problems in future whilst tactically speaking benefiting from a better funding level.

The chart below compares the liabilities valued using the full market-based curve with the alternative truncated 40-year curve.

Source: Aberdeen, 30 April 2025

Final thoughts

Changing liability valuation approach isn’t a new idea. In the past, pension schemes used swaps rather than gilts. 
An alternative approach to valuation - such as using a truncated curve - could offer more flexibility and perhaps a practical way for pension schemes to manage long-end concentration risks without compromising the ability to generate long-dated cashflows.  

All data is from Aberdeen as at 30th April 2025.