Funds go cold on new gilts issues

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The Independent Online
The Government may struggle to fund its pounds 50bn borrowing requirement because of a reluctance among institutions to increase their holdings in gilts.

An Independent survey of fund managers responsible for investing about pounds 300bn, or 40 per cent of all UK pension and insurance funds, shows that none intends to buy more gilts than usual unless market conditions change.

This suggests that the Government, which intends to issue pounds 1bn worth of gilts per week next year, will have to rely on overseas investors and individuals to finance its borrowing requirements.

Many of the 12 large investors surveyed also believed the prospects for shares or overseas bonds - including US treasuries - are better than for gilts.

The survey, covering the largest fund- management groups including Invesco MIM, Schroders Investment Management and Standard Life, also reveals widespread City scepticism about the Government's ability to keep the lid on inflation.

Keith Percy of Morgan Grenfell Asset Management, with pounds 21bn under management, said: 'My view is that the UK economy is inflation-prone.' Low inflation is traditionally seen as an attractive background for buying fixed-interest gilts.

Barry Southcott of CIN, which manages the pounds 14bn British Coal pension funds, said: 'Government policy is to get growth going. The risk is with future inflation.'

One fund manager who preferred not to be named said the economy had already received a huge stimulus from successive cuts in interest rates, a 20 per cent drop in the value of the pound and increased public spending. This could push up inflation.

Some of those who were fearful about inflation hold index-linked gilts, which rise in value with retail prices, rather than fixed-interest or conventional gilts. Barclays de Zoete Wedd Investment Management, with pounds 30bn under management, intends to switch out of fixed interest to index-linked gilts.

A minority were more confident about inflation prospects. Dick Barfield of Standard Life said: 'Inflation is under reasonable control.' But he still believes that equities offer better prospects than gilts.

Nearly all the fund managers interviewed expect the full-funding rule to be changed so that gilts bought by banks and building societies will count towards the borrowings requirement in the same way as gilts bought by pension funds and insurance companies do. This move would reduce the pressure on institutions to buy gilts.

Many said they might rethink their stance if gilt yields rose. Nicholas Sykes of Baring Investment Management, with pounds 22bn under management, said: 'If yields on long gilts got to 9.5 per cent we might be tempted.' But others said high gilt yields would knock share prices, making them more attractive relative to gilts.

Legal & General, the insurance company which manages pounds 20bn of funds, is one of several houses that believe shares offer better prospects than gilts. L&G's David Shaw said: 'Our analysis is not good news for the government broker.'

Norwich Union, which in 1991 announced that it was switching money into gilts, also believes shares will outperform conventional gilts in the long term. It has about 17 per cent of its life insurance fund invested in gilts.

The average pension fund has only 3.2 per cent of its assets in fixed-interest gilts and a further 2.5 per cent in index- linked gilts, according to Combined Actuarial Performance Services.

Far from increasing their holdings, some fund managers have recently cut their holdings.

Lloyds Investment Management, with pounds 7bn under management, has reduced its exposure to fixed-interest gilts from 7 per cent to 4 per cent, while retaining 5 per cent of its portfolio in index-linked gilts.

Some fund managers said a growing number of pension funds were maturing - having to pay out more in pensions than they were receiving in contributions. These funds tend to have higher weightings of gilts as gilts produce a higher income than other holdings.

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