Pension Income: Why Gilt Yields Won't Rise

Gilts determine all important annuity rates - meaning investors approaching retirement are willing them to rise. But one fund manager says its a lost hope

David Brenchley 24 November, 2017 | 4:43PM

Think gilt yields are unusually low? Guess again; a chart of long term government bond yields shows payouts can, and do, stay low for long periods of time. In fact, the "new norm" of record low gilt yields is simply a return to form for government bonds.

The outlying observation is not where gilt yields are today, but where they were 30 years ago.

During the Sixties, gilt yields averaged around 6%, whil in the Seventies they hit as high as 12%. Even in the Nineties, annuity investors had the benefit of a base rate of around 5%. But now, gilt yields are less than 2% - and Stephen Snowden, head of fixed income at Kames Capital, says the current measly return is likely to continue for the foreseeable future.

Snowden, manager of the Morningstar Silver Rated Kames Investment Grade Bond fund, says a chart tracking gilt yields since they were first introduced in 1694 suggests the current low environment is not the outlier.

Chart showing gilt yield back to 1600s

“If you were to come to planet Earth on your spaceship from Mars to be presented with that chart, you would say the outlying observation is not where gilt yields are today, but where they were 30 years ago,” he explains.

“What we’ve seen in the past is that yields have been very low for protracted periods of time. Just because they were high in our investment experience, doesn’t make it a pre-determined fact.”

That has a knock-on effect for retirees, as annuity rates are closely linked to gilt yields. When yields rise, so should annuities. Should they stick around these levels, any allure they have post-pension freedoms will evaporate even more.

Still, analysis from online platform Hargreaves Lansdown earlier this month showed that as gilt yields rose in anticipation of an interest rate rise, so did annuity rates. In September 2016, a £100,000 pension would have bought a 65-year-old £4,495 of secure annual income, according to HL. At the beginning of November 2017, it would buy £5,209.

Fund Managers are Too Old

Snowden says the fundamental problem with fund management is that “everyone is too old”. He and his cohort were brought into the investment community with gilt yields in double-digits. That led to what’s been a 30-year bull market for bonds.

For the majority of the 1973-1992 period, interest rates rarely strayed below 10% for more than a few months at a time. That’s unheard of now.

“I was sat in an economics lecture at University when the UK came out of the European Exchange Rate Mechanism in 1992,” Snowden says.

“My first mortgage was 8.6%. For people of my generation, all you’ve seen is a huge rise in the bond market and what we all know from the tech bubble crisis is what goes up must surely come down.”

Snowden suggests there are two ways to remedy the view that bond yields are too low relative to history: “What we need to do is either sack me and my cohort and bring in 21-year-olds who’ve never seen an interest rate rise until last week, or we may have to reincarnate people from the past.”

While Snowden believes yields will stay low for a long time now, he is hopeful the post-Brexit low of around 0.75% will be a nadir. While the 10-year gilt yield of around 1.25% today looks a little bit expensive, Snowden does not think it’s “materially wrong”.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Kames Investment Grade Bond A Acc175.24 GBP-0.07

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk