Index-linked gilts vs I-L Gilt Funds?

itm2

I'm planning to retire shortly (mainly on drawdown income) and want to take some measures to insure my retirement pot against inflation. I was planning to allocate a portion to index-linked gilts, but was mulling over whether I should invest directly in them, or invest in an index-linked gilt fund.
Direct investment would have the advantage of a tax-free yield (apart from the yearly coupons), but prices seem inflated at the moment and I've heard that I-L Gilt funds often perform better in terms of growth and overall yield.
Does anyone have any views/experience on these two options?

Ark_Welder

Firstly, the interest paid on a direct holding is tax-free only if held in an ISA or a SIPP (or you're a non-taxpayer and won't be pushed into being a taxpayer). The interest is (or can be) paid out gross, but this does still suffer tax at your marginal rate. Any tax paid on interest from a holding an IL gilt fund can be reclaimed if any of the similar circumstances apply.

The main advantage of individual holdings is that the return can be tailored to a specific date, i.e. the gilt's redemption date.Now, buying one today will likely result in a return that is lower than inflation over the term, but if inflation happened to work out at 15% and your return was 'only' 14% then that might not be so bad. And even a fund that tracks this sector will have a charge, which can be avoided - unless the purpose of the fund is to allow a manager to actively move between longer and shorter durations depending upon the outlook.

Where your potential return could not be determined is if the gilt was sold before redemption, at which point the prevailing market price would apply. And that is the main disadvantage of holding a fund: the price of the units will always be a reflection of the general sentiment towards the sector, depending upon the outlook for inflation and interest rates...and creditworthiness...etc. So sentiment could turn against you when the time does come for the holding to be sold, whereas the individual holdings will eventually be priced/redeemed at their inflation-adjusted price.

itm2

Thanks for your reply. My assumption was that the bulk of the return on I-L Gilts would be on the index-linked capital gains (which would be tax-free if invested directly), and that the semi-annual taxable element would be less significant from a tax point of view. Is that correct?
If I have no specific redemption date in mind - i.e. the investment is purely to insure a larger portfolio against inflation over a 25+ year period, would I be better off with an I-L Gilt fund?

kidmugsy

itm2 wrote: »

If I have no specific redemption date in mind - i.e. the investment is purely to insure a larger portfolio against inflation over a 25+ year period, would I be better off with an I-L Gilt fund?

Are you tempted to buy an annuity when you become 75? That would then give you a target date for an ILG.

The point is that a bond, index-linked or not, is a very different beast from a bond fund. The bond has a known maturity date, a known set of payout dates, and known payouts (in either nominal or real terms). The fund has none of these properties; its performance is governed in part by the money washing in and out of it as customers buy and sell units.

itm2

kidmugsy wrote: »

Are you tempted to buy an annuity when you become 75? That would then give you a target date for an ILG.

The point is that a bond, index-linked or not, is a very different beast from a bond fund. The bond has a known maturity date, a known set of payout dates, and known payouts (in either nominal or real terms). The fund has none of these properties; its performance is governed in part by the money washing in and out of it as customers buy and sell units.

No I have separate plans for annuities, using specific funds invested in 1980s plans which have good GAR's. This line of enquiry relates only to the drawdown pot, a balanced set of holdings which I anticipate leaving invested indefinitely.

kidmugsy

In that case, and with a generalised fear of inflation as your motive, might you be interested in a fund/ETF covering international index-linked bonds? In other words, diversify from depending on just one government honouring its obligations.

itm2

kidmugsy wrote: »

In that case, and with a generalised fear of inflation as your motive, might you be interested in a fund/ETF covering international index-linked bonds? In other words, diversify from depending on just one government honouring its obligations.

The international element is an interesting idea, although I can't decide how pertinent it would be to me if I have no plans to move away from the UK.
Does the lack of a defined redemption date make I-L funds a better long-term idea than direct gilt purchases? If the purpose of the exercise is to maximise the value of my portfolio while insuring against inflation is there any reason to believe that the value of a holding in I-L funds would hold up better than a series of direct investments in gilts in the long term?

kidmugsy

itm2 wrote: »

If the purpose of the exercise is to maximise the value of my portfolio while insuring against inflation is there any reason to believe that the value of a holding in I-L funds would hold up better than a series of direct investments in gilts in the long term?

I don't know the answer. The fund will have investments that change with time: when people cash-in units it will sell some of its holdings; when people buy units it will buy gilts at whatever price they command on the market. That's quite different behaviour from that of an individual gilt holding, which is the only sort I've any experience of.

A second thought: which is the cheaper way to buy and hold gilts? If a fund charged something appreciable for management, that might knock quite a hole in your returns.

Sorry I can't be more helpful.