how reliably do index linked investments beat inflation?

deadpeasant

Over the last 10 years, an index linked gilt fund steadily outperforms RPI. E.g.:

---RPI M&G Index Linked Bond
1y 5.19% 12.87%
3y 8.64% 21.15%
5y 18.49% 38.85%
10y 35.72% 81.23%

This seems like a relatively low-risk, low-volatility way of beating inflation. But I've read of a 30 year bull market in bonds - is the outperformance of inflation under threat? And I don't have a good enough grasp of the sovereign debt issue to know if this is relevant?

Debbie_A_3

Hi dp,

Index linked bonds are more complicated than index linked savings certificates. They only do what they say on the tin if you buy them at creation and hold them to redemption. Between these dates the captial value will fluxuate (it will go up if the markets think interest rates will fall or inflation will rise; it will go down if vice/versa). A bond fund like M&G will buy and sell bonds to try and profit from this volatility. They may get it right, but they could also get it wrong. So there is no guarantee.

When it comes to sovereign debt worries, you are probably OK with UK and US debt since the respective governments can simply print more money if they get stuck (and efffectively share out the pain between everyone with wealth stored in their currencies). Euro debt may be a different matter, but time will tell on that one.

deadpeasant

Thanks

Debbie_A wrote: »

the captial value will fluxuate (it will go up if the markets think interest rates will fall or inflation will rise; it will go down if vice/versa).

So, if the fund has grown steadily over 10 years, does that mean that over that period the markets have consistently thought that interest rates would fall and/or that inflation would rise? Both have fluctuated over the last decade. Or does it just mean that this fund (and others in the sector, which seem to perform similarly) were well managed?

(And I'm still curious as to what the so-called 30 yr bull market in bonds is referring to.)

sabretoothtigger

Yes rates have fallen over the last 10 years. As such a fixed rate bond will have become more valuable in that time, it has been unexpected and I would attribute any good fund returns more to this 'random' event then good management


Inflation has not fallen as greatly as interest rates so index linked should have outperformed

is the outperformance of inflation under threat?

Rates cannot fall (much) further. The worth of debt is far more likely to reverse as UK is examined for credit worthiness. As our budget is overspending we need markets far more then they need us so demand vs supply is likely not to favour prices as it has done previously
Also as a currency we could become less popular leading to lower demand for our bonds

The gilt pricetag includes 200bn held by BOE , either way they are a future seller

30 yr bull market in bonds is referring to.)

http://1.bp.blogspot.com/_yrnL7w7J_ps/TQfIOm9NZ_I/AAAAAAAAAEI/CUo1o7Dn4rA/s1600/US+Long+Bond+Weekly+for+Craig-2.jpg
http://tfmetalsreport.blogspot.com/2010/12/bonds-and-expatriation.html



Its saying the price rose for 30 years. If the return is fixed why is price rising. If inflation doubles, I still think less demand for linked bonds exists as there is better currency then ours available

deadpeasant

sabretoothtigger wrote: »

Yes rates have fallen over the last 10 years. As such a fixed rate bond will have become more valuable in that time

But rates rose for much of the last 10 years and only fell sharply after the meltdown. Whereas the graph for the IL gilt sector just rises steadily over the last 20 years (admittedly a bit steeper since the meltdown).

If it only outperforms RPI by a little, with less volatility than equities, it still seems quite an attractive alternative to savings.

(Enjoyed the expatriation link - thanks!)

pqrdef

Index-linked bonds do pay a coupon as well as having an index-linked redemption value, so other things being equal you'd expect an accumulation fund to outperform RPI. But that boat's been missed now, because at current prices the coupon isn't worth much.

Ark_Welder

BoE Base Rate was 6% in 2000, moved down to 3.5% by 2003, and moved back up to 5.75% by 2007.

The bond bull market does not mean that their price keeps rising (talking about conventional rather than IL) - they will not because bonds will have a redemption price on a specific date, usually 100%, so (assuming no auctions etc), £100 nominal bought at issue will result in £100 being returned on the redemption date. So the old 13% Treasury gilts etc that were launched in the '70 and '80 would have been issued at £100 and redeemed for £100. However, when interest rates began falling the prices of these rose so that the running yield for subsequent investors was lower than 13%. As the redemption date came closer, the prices of these bonds fell back to their redemption price.

Because interest rates have been falling since the '80s, the yields at issue for new bonds and gilts has been lower. The bond 'bull market' reflects the temporary rise in price of older, higher-yielding bonds, and the fact that newer bonds have been able to be issued with lower yields. This is the potential problem with buying bonds and gilts now: when interest rates start to rise then the yields on the bonds will also rise, i.e. the price of the bond will fall. The prices will eventually return to their redemption price when their redemption dates are near, but that could be a good few years away.