Surrey sets up trigger-based framework for £90m gilt repo move

The fund has set aside £90m for gilt repurchase agreements or ‘gilt repos', in an attempt to limit its exposure to unrewarded economic risks such as price and rate movements. These strategies have become common in the industry for schemes that want exposure to gilts without having to tie up capital.

The Surrey scheme appointed its existing gilts manager, Legal & General Investment Management, to manage the new brief, which will only come into play should certain inflation or interest rate triggers be reached.

However, the fund still has to determine just what these trigger points will be. Phil Triggs, strategic finance manager for the council's pension fund and treasury function, said: “The contracts that have been signed only relate to the restructuring of the physical gilts. No investment will take place yet in the leveraged gilt structure.

"The switch will take place based on yield triggers which are still to be decided, assuming real yields get back to 0 per cent.”

To minimise the costs of the overall restructuring, the manager moved the pension fund’s index-linked gilt holdings, which were held in an all-stocks fund, into a series of single stock index-linked gilt holdings that broadly correspond to the liability profile of the fund.

“The leveraged gilt portfolio ultimately targeted by the fund will invest in leveraged versions of the single stock funds." said Triggs. "Restructuring now will make it quicker and cheaper to move into the leveraged structure when the trigger point is hit. This will be the most cost-effective way for ultimately moving to the leveraged gilt structure.” 

He added: “As [Surrey’s investment consultant] Mercer puts it, it’s about getting the plumbing in place. We want to be able to move quickly.”

The Surrey local authority pension fund says the gilt repo activity is just the start of a programme of hedging which will increase as the scheme moves towards full funding.

How repos work

The gilt repo market has become increasingly attractive for UK pension funds since gilts are priced more cheaply than swaps, while at the same time tie up capital and have none of the leverage inherent in swap arrangements.

A gilt repo sees a pension fund buying a set amount of gilts, selling these to a bank with an agreement to repurchase them at a future date, and using the proceeds to buy more gilts. It then repeats the process, allowing it the derisking benefits of gilts without sacrificing assets that could be better used to deliver excess return.  

Robert Gall, head of market strategy in the financial solutions group at asset manager Insight Investment, said: “The most obvious way to get economic exposure to gilts without tying up capital, which might be used to buy growth assets and close deficits, is via the repo markets. It has become standard and is an industrywide phenomenon.”

Colette Christiansen, head of derisking solutions at consultant Punter Southall, said other schemes were now moving beyond simple gilt repo structures. “These came around two to three years ago and the latest iteration is dynamic funds, which automatically switch between swaps and gilts depending on which is better value,” she said.

She added relatively few funds are doing leveraged gilts in isolation, and are instead favouring combining these with swaps.