BlackRock’s UK gilt ETF hit a significant discount to net asset value (NAV) on Tuesday amid a rout in the underlying UK sovereign debt market.
The exodus came as Bank of England speeches earlier in the week did little to stimy market unrest following the unfunded tax cuts set out by Chancellor Kwasi Kwarteng in his ‘mini budget’ last Friday.
As yields on two and 10-year UK gilts across the curve spiked to their highest level since the Global Financial Crisis in 2008 and asset prices plummeted following the ‘fiscal event’, final-salary pension schemes that have hedged their ability to make future payments – termed liability-driven investment (LDI) strategies – were particularly sensitive to this volatility in UK sovereign debt.
The Bank of England noted pension funds were having to offload their UK gilt exposure to meet the cash demands of their creditors, putting them at risk of insolvency as rapid selling activity further deflated the price of the assets they were offloading.
Amid these mass sales, Europe’s largest broad UK gilt ETF, the $1.2bn iShares Core UK Gilts UCITS ETF (IGLT), saw its price per share drastically dislocate from its NAV when it traded at a 1.08% discount on Tuesday, according to data from Bloomberg Intelligence.
For context, this deviation from its NAV is some 180 times greater than its historical average and far surpasses its previous largest dislocation in 2022, when it traded at a 0.66% premium on one day in February.
These moments of ETF price deviation – which some have termed ‘price discovery’ – occur as ETFs are traded intraday on exchange, whereas the NAV of IGLT’s underlying is calculated on a daily basis, meaning they do not provide a live picture of pricing volatility.
Thankfully, IGLT’s high discount and those of other UK gilt ETFs will have been restored to something more closely resembling normality after the Bank of England announced on Wednesday it will implement a targeted round of quantitative easing (QE), buying £65bn of UK gilts with more than 20 years to maturity, at a rate of £5bn per day.
In a statement, the central bank said: "Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability."
It added its QE intended to restore market stability and “the purchases will be carried out on whatever scale is necessary to effect this outcome”.
The Financial Timesreported Kerrin Rosenberg, CEO of Cardano Investment, which manages LDI strategies for around 30 UK pension schemes, wrote to the UK’s central bank on Wednesday, stating: “If there was no intervention today, UK gilt yields could have gone up to 7-8% from 4.5% this morning and in that situation around 90% of UK pension funds would have run out of collateral. They would have been wiped out.”
Chancellor Kwarteng’s tax cuts have not been received well by market participants on a global scale, with sterling briefly falling to its lowest level since the dissolution of Bretton Woods in 1971 on Monday and UK gilt yields displaying multi-decade-high volatility last Friday.
Aside from the pension fund run on UK gilts, corporate borrowing costs also surged and UK mortgage markets went cold as banks temporarily suspended signing new agreements.
On Tuesday, credit ratings provider Moody’s warned: “A sustained confidence shock arising from market concerns over the credibility of the government’s fiscal strategy that resulted in structurally higher funding costs could more permanently weaken the UK’s debt affordability.”
Looking ahead, markets will watch closely at whether the government doubles back on its tax cut plans – as requested by the International Monetary Fund – or whether they double down on their core leadership campaign policy with further spending plans at this weekend’s Conservative Party conference and the Chancellor’s Autumn Budget on 10 November.
Mike Owens, global sales trader at Saxo Bank, said on the new QE and Bank of England’s interaction with the government: “This move from the Bank of England will not stem moves against the UK debt and currency markets on their own.
“It is a narrowly defined intervention that hopes to dampen the current shocks. We are told that the BoE is meeting with the Treasury routinely week-on-week, and so now the focus will swing back to how the government plan to convince the market that their expansionist policy will provide the growth necessary to balance the UK’s finances.”
For now, the central bank expects its longer-dated bond buying to run until 14 October. It then plans to begin its quantitative tightening cycle – previously targeting £80bn of sales in 12 months – from 31 October.
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