A noddy question about Gilts / Bonds

Cleaver

Apologies if this has been asked before - I've had a quick trawl through past posts and couldn't see much about gilts / bonds.

I think I understand the princple of a government gilt (you effectively loan them money on a 5, 10, 20, 30, 50 etc year basis for a guaranteed percentage return). I've seen some advertised at 3% or 4%. My first question was why would someone invest in something so low, but I saw a previous posting which stated that you're basically tacking an interest hit as they are such a secure and long term investment.

But I was reading an article in the Sunday Time Money section this morning about how different fund managers would invest their money at the present time. One of them (David Kaunders for any of you money geeks out there) was recommending gilts and the summary at the end said the following:

"You can now buy 2009 UK gilts with a running yield of 3.9%. Five year gilts are yielding 4.3%, 10 year 4.4% and 20 year 4.5%. *...bit of waffle...* M&G Index Linked Bond fund has an entry level of £500 or £10 per month and is up 10% in the past year. At present it has a yield of 1.32%".

So now I'm confused. Taking this M&G Index thingy, if you invested money would it give you a 1.32% return or a 10% return? I'm not really thinking of investing in this area, I just can't seem to find a decent internet article which nicely explains how these things work. Surely people don't tie up money for 30 years just to get a 3% return do they? Or have I missed something? Anyone on here got these things are care to reveal how much they make for them?

Cleaver

Just to guess the answer to my own question!

Does my example at the bottom of my post mean that if you had invested £10,000 and the fund goes up 10% and you get 1.32% yield, it means you get an interest payment at the end of the year of £132, but your initial £10,000 is now worth £11,000?

Or have I got that wrong too?!

cheerfulcat

Hi, Cleaver,

Cleaver wrote: »

I think I understand the princple of a government gilt (you effectively loan them money on a 5, 10, 20, 30, 50 etc year basis for a guaranteed percentage return). I've seen some advertised at 3% or 4%. My first question was why would someone invest in something so low, but I saw a previous posting which stated that you're basically tacking an interest hit as they are such a secure and long term investment.

But I was reading an article in the Sunday Time Money section this morning about how different fund managers would invest their money at the present time. One of them (David Kaunders for any of you money geeks out there) was recommending gilts and the summary at the end said the following:

"You can now buy 2009 UK gilts with a running yield of 3.9%. Five year gilts are yielding 4.3%, 10 year 4.4% and 20 year 4.5%. *...bit of waffle...* M&G Index Linked Bond fund has an entry level of £500 or £10 per month and is up 10% in the past year. At present it has a yield of 1.32%".

So now I'm confused. Taking this M&G Index thingy, if you invested money would it give you a 1.32% return or a 10% return? I'm not really thinking of investing in this area, I just can't seem to find a decent internet article which nicely explains how these things work. Surely people don't tie up money for 30 years just to get a 3% return do they? Or have I missed something? Anyone on here got these things are care to reveal how much they make for them?

You are only lending money if you buy gilts or bonds at issue. If you buy them in the market, you are buying the loan - that is, the right to the interest payments and the final repayment.

As you say, people who buy gilts are generally risk averse. Yes, the interest rates are on the low side but you have a known stream of income and capital repayment. The UK government has never ( yet ) defaulted so gilts should be 100% safe. There is still inflation risk, of course, but index-linked gilts have an even smaller return.

The tying up for 30 years - no, I would imagine that there aren't many retail investors who would want to do this, though if you had a large enough amount of capital it might be tempting to secure 30 years' worth of income, however low. It would be mostly pension funds interested in those durations.

Bear in mind that there is also the possibility of a capital gain - in times of difficult markets, there can be a " flight to quality " - this drives down yields, giving you a nice tax-free gain if you bought when the yield was higher.

The M&G fund question - you would have the income ( yield ) and the rise in capital value.

HTH

Cheerfulcat

Cleaver

cheerfulcat wrote: »

Hi, Cleaver,



You are only lending money if you buy gilts or bonds at issue. If you buy them in the market, you are buying the loan - that is, the right to the interest payments and the final repayment.

As you say, people who buy gilts are generally risk averse. Yes, the interest rates are on the low side but you have a known stream of income and capital repayment. The UK government has never ( yet ) defaulted so gilts should be 100% safe. There is still inflation risk, of course, but index-linked gilts have an even smaller return.

The tying up for 30 years - no, I would imagine that there aren't many retail investors who would want to do this, though if you had a large enough amount of capital it might be tempting to secure 30 years' worth of income, however low. It would be mostly pension funds interested in those durations.

Bear in mind that there is also the possibility of a capital gain - in times of difficult markets, there can be a " flight to quality " - this drives down yields, giving you a nice tax-free gain if you bought when the yield was higher.

The M&G fund question - you would have the income ( yield ) and the rise in capital value.

HTH

Cheerfulcat

Thanks for all of the above Mr Cat, much help. The rise in capital is something I didn't realise existed with these things - it makes their appeal much more understandable.

Anyone know a good website for comparing and looking at previous performance of these types of products?

Reaper

Cleaver wrote: »

The rise in capital is something I didn't realise existed with these things

Just to be totally clear - this works both ways.

If you own a gilt and want to sell it before maturity you won't get the same price you paid for it. Broadly if interest rates are lower than when you bought it you will make a profit. If interest rates are higher then you can expect to make a loss.

The price is also affected by how close to maturity they are. The nearer to maturity the closer the value will become to the starting capital.

Some people make the mistake of thinking of gilts as 100% safe. They are if you mean you will get your capital back when they mature, but if selling before that the amount you get for them fluctuates.

stevetodd

Cleaver wrote: »

Thanks for all of the above Mr Cat, much help. The rise in capital is something I didn't realise existed with these things - it makes their appeal much more understandable.

Anyone know a good website for comparing and looking at previous performance of these types of products?

Try this:

http://fixedincomeinvestor.selftrade.co.uk/x/mem_selftrade/default.html

If you select a gilt (or corporate bond) 5 years or over you can wrap it up in a stocks and shares isa making the interest tax free

cheerfulcat

Cleaver wrote: »

Anyone know a good website for comparing and looking at previous performance of these types of products?

If you mean gilt funds, try Trustnet.

You might also be interested in this short ( free! ) course from Incademy, which gives a good basic explanation of how gilts and bonds work and are priced.