Barclays Capital has published its fiftieth annual Equity Gilt study, in which it argues that historical experience continues to support equity investment for long-term investors, despite UK institutional investors’ shift to asset and liability matching strategies.
Pension funds and insurers have been moving out of equities and into long-dated gilts and high-rated corporate paper, spurred on by the introduction of the Financial Services Authority’s new prudential capital regime in 2002.
But the effect of adopting this asset/liability matching philosophy has been to depress long-term real and nominal bond yields, while cheapening equities relative to bonds.
The study notes that last year’s corporate bond returns, at 3.3%, were significantly weaker than the 10-year average of 8.5%. Gilts returned 3.6%, down from a 10-year average of 6.5%, while equities returned 8.8%, up from a 10-year average of 5%
Changes to pensions regulations in Europe could tip European institutional investors’ long-term strategies in the same direction, bringing further pressure on the long end of the fixed-income markets. There are two major regulatory drivers. Solvency II is the capital supervisory model for the insurance industry. The EU Pensions Directive, meanwhile, is “explicit in encouraging a move to asset and liability management”, according to the report.
The changes to EU policy are themselves driven by Europe’s burgeoning elderly population, which is rendering purely state-funded pension provision impossible.