UK fixed income investor PIC ponders the long term risk of government debt

The United Kingdom’s Pension Insurance Corporation (PIC) is beginning to re-evaluate how it thinks about US Treasuries and developed market government bonds as safe-haven assets. It’s not only the recent sell-off in US Treasuries, which usually offer welcome shelter for investors in times of volatility, that has CIO Rob Groves concerned.

Echoing other institutional investors, he says Western economies including France and the UK have long-term growth, productivity, and demographic challenges brewing that raise the risk of these government bond prices falling in value too.

“It will play out slowly, but major western economies face long term challenges,” he says in conversation with Top1000Funds.com after markets plummeted following President Trump’s rewriting of global trade norms in April.

He expects investors will be increasingly mindful of  governments demonstrating “real fiscal discipline” to avoid the risk of another “Liz Truss moment” when the former UK Prime Minister’s short-lived government policies triggered a run on the gilt market (and leveraged LDI strategies added fuel to the fire.)

“The Chancellor, Rachel Reeves, has a challenging fiscal position to manage,” says Groves.

Some 80 per cent of PIC’s portfolio is invested in low-risk investment-grade fixed income spanning corporate and UK government bonds, largely managed in-house – at the end of 2024, 92 per cent of the portfolio was rated investment grade. Matching assets with liabilities – so that if its assets fall, liabilities also fall at the same time – is strictly regulated for the insurer, which is restricted on where it can and can’t invest.

PIC takes on offloaded corporate DB schemes either through a buyout model whereby pension fund members become policyholders, or a buy-in model where trustees can secure the pension payments to their members through a contract with PIC.

“Think of it like an M&A process where we take on the responsibility of DB schemes which wind up and cease to exist. We manage the portfolio and pay the pensions and seek long-term stable secure cash flows that give the best returns and help us secure new business,” explains Groves.

Opportunity in corporate credit slow to emerge

Long-term PIC is focused on Western government solvency. In the short term, Groves is ready and waiting to take advantage of the current volatility in markets.

PIC has significantly de-risked its portfolio over the last 18 months on the basis that assets are expensive and investors have not been significantly rewarded for the risk. The insurer took on around £8 billion ($10.5 billion) in new liabilities through 2024 but has been slow to deploy the money because it is wary of locking in a smaller return relative to what it can earn on gilt yields. It leaves the PIC sitting on record liquidity and solvency levels – it currently has a solvency ratio of 237 per cent compared to 211 per cent in 2023.

“Going into the crisis we were about as well prepared as it was possible to be,” says Groves.

But despite market turmoil, opportunities to buy have not manifested in investment-grade corporate credit where PIC particularly hunts for opportunities. Around 40 per cent of assets are in the US, home to the largest and most liquid corporate bond market in the world, and opportunities for PIC open up when investment-grade credit spreads become more attractive.

Although prices have fallen on the screen, there is very little liquidity.

“Traders are marking their books down, but there is not much inventory to buy,” says Groves. “There is no forced selling which is a feature of a crisis. However, if tariffs aren’t rolled back there could be an extended period of market turbulence.”

Any further leg down in markets could be triggered by negative hard data in growth numbers and corporate earnings, he suggests.

Growth in private markets

If volatility returns and credit spreads increase, Groves also expects to see more opportunities to invest in higher-yielding private assets too. PIC focuses on UK infrastructure debt and housing particularly; lending is inflation-linked and comes with good terms like covenants and at attractive prices. Private assets also provide valuable support on “filling the gaps” on cash flows out, he says.

To date, PIC have invested almost £14 billion in the UK in sectors like social and affordable housing, urban regeneration projects,  renewable energy, and the UK’s universities.

On the equity side, PIC has a new stake in the build-to-rent sector where the investor works with developers to build flats that it owns and rents out over the years. New investments include a new residential community adjacent to Manchester Victoria train station.

However, Groves notes that originating private assets that work for the insurer has become more challenging in the last 18 months. He returns to the point that, unlike other asset owners, PIC is not an absolute yield or return investor but a spread investor – when PIC deploys money taken on from the schemes it manages, it sells gilts and buys credit.

“It’s not the absolute level of return we care about it’s the spread and how much extra return we can earn on the credit over gilts,” he explains. “Credit spreads are very low, and asset prices are expensive which makes a difficult investment environment for us. Take a typical borrower like a Housing Association. They care about the cost of the debt, not the credit spread. They think it’s expensive to borrow because of higher interest rates but we think it’s expensive to lend. Neither party is getting good value.”

Although annuity providers dominate long-term debt provision in the UK, he cites other challenges crimping investment opportunities too. In social housing, investors are challenged to retrofit existing property in order to meet new energy-efficiency and other regulatory requirements, for example.

“In the current market, a nice infrastructure lending opportunity will be five times oversubscribed – there is no shortage of capital to invest. However, it’s difficult to get projects off the ground because planning and regulations are impediments to these projects.”

PIC doesn’t have a strategic asset allocation but looks for opportunities on a deal-by-deal basis. “When we are pricing up a new pension scheme, we look for things we can invest in on a line-by- line basis,” he says.

The 100-person investment team (grown from 16 when he joined) is split into different teams. One manages the assets and liabilities and is responsible for pricing new business and optimising the current portfolio as well as interest rate and inflation hedging. A trading team execute all trades, and a public credit team manages the corporate bond portfolios in a strategy that is being gradually insourced, supported by a credit research team that evaluates and assigns credit ratings and interacts with borrowers. Other departments manage private debt origination and a strategic equity team hunts for interesting long-term income-generating assets.

PIC also runs a small £3 billion Alternative Fund portfolio that has allocations to hedge funds, a little private equity and healthcare royalties.

“It’s a really stable producer of returns,” he says.