Record negative UK Index linked bond yield

Pincher

Masomnia wrote: »

Both the capital value and the coupon are up-rated with inflation so how do you work out that you get 'half your money back'?

I am under the impression that the yield (-1.77%) takes into account the coupon payments as well.

If you have to do a coupon calculation every time, quoting the yield is pretty useless.

EdGasket

Without knowing the future inflation rate it is hard to value these index-linked gilts. With hyperinflation, they could be among the best investments; at least holding the value of your money whereas other cash and traditional bond investments would be wiped out in that scenario.

Glen_Clark

EdGasket wrote: »

With hyperinflation, they could be among the best investments; at least holding the value of your money whereas other cash and traditional bond investments would be wiped out in that scenario.

half your money, providing the BoE stems the rising National Debt and stays solvent and doesn't continue to manipulate the inflation rate.
I just posted it as an illustration of how distorted the markets have become through QE.
Yet people still seem to expect other investments to produce the real returns they have in the past. Seems doubtful to me. But we are in uncharted waters so I suppose nobody knows what is going to happen..

Malthusian

Certain institutions are forced by law and regulation to hold index-linked gilts, e.g. pension funds. We can only assume that this particular index-linked gilt, while awful value from the perspective of an ordinary punter, was more attractive than other index-linked gilts on the market, hence the oversubscription.

EdGasket wrote:

Without knowing the future inflation rate it is hard to value these index-linked gilts. With hyperinflation, they could be among the best investments; at least holding the value of your money whereas other cash and traditional bond investments would be wiped out in that scenario.

In order to be able to pay the coupons on index-linked gilts at a time of hyperinflation the Bank of England would have to run off a load more trillion-pound notes. This would stoke hyperinflation even further, the end result being that by the time you had received your hyperinflation-linked coupon I suspect they would be virtually worthless already. I would expect the government to at minimum suspend coupons on index-linked gilts to avoid stoking hyperinflation any more than it has to, if it didn't default entirely.

If the UK was in a Zimbabwe scenario the best investments would be 2. anything not in the UK 1. a boat ride off the island.

EdGasket

Yes good point, but I suppose index-linked might do well where inflation is above expectations but not in the hyper-inflation territory.

Sorry Glen Clark, I don't get the 'half your money' bit? If index linked keeps up with inflation and pays a coupon then I don't see how you lose half your money?

Pincher

EdGasket wrote: »

Sorry Glen Clark, I don't get the 'half your money' bit? If index linked keeps up with inflation and pays a coupon then I don't see how you lose half your money?

If a bond has a face value of £100, and you paid £150 to buy it.

The £100 they pay you in ten (or 36) years time is worth £50, say, present value. Assuming all the coupon payments plus the final £100 is worth £75 present value, you will have

Paid £150

Got back £75, in today's terms.


75/150=0.5=HALF.

Taylor Swift concert ticket logic, probably.
I wouldn't pay £10 for one, but somebody will pay £150.

EdGasket

In the example you give, it is a traditional bond with no inflation linking so of course you would lose money to inflation.
However with index-linked your money keeps up with inflation so you don't lose unless inflation is very low vs interest rates. So if inflation is high you do better. But whatever the logic, agreed they are very expensive.

Reaper

Malthusian wrote: »

Certain institutions are forced by law and regulation to hold index-linked gilts, e.g. pension funds.

Are they? I hadn't heard of that. They buy a lot but I just assumed it was lazy, conservative investing.

I can tell my company pension to invest in one of a range of funds so I am not sure how that fits in.

Can you provide some info or links on their legal obligation to buy them?

grey_gym_sock

it looks like they sold some more of an index-linked gilt issue which was first issued in c. 2012 ... see the price graph here: http://www.fixedincomeinvestor.co.uk/x/bondchart.html?id=3634

for more figures, see http://www.dmo.gov.uk/ceLogon.aspx?page=D1D&rptcode=D1D and search for 2052 ... i think what the numbers there mean is:

there is £11,966.02m of this gilt issue out there, at the original nominal value.

but due to total inflation since the original issue (c. 4 years ago) of 8.808%, the nominal value has grown to 1.08808 x the original amount, making £13,019.99m.

it pays 0.25% interest. this grows with inflation, so it's currently paying 0.25% of £13,019.99m per year.

the annual interest will continue to grow with inflation, and the final repayment value will be £13,019.99m increased in line with the inflation between now and 2052.

however, if you're buying this gilt on the open market today (and the DMO will have sold the additional gilts for something similar to this), you have to pay 2.0157 x the nominal value including inflation uplift so far, making the market value of the total issue 2.0157 x £13,019.99m = £26,244.93m.

so, assuming you could buy the whole issue at that price, you'd pay £26,244.93m now, and get back
a) 0.25% interest on £13,019.99m per year, for 36 years, adjusted for inflation (so the initial interest is c. 0.12% of what you pay); and
b) £13,019.99m capital repayment after 36 years, adjusted for inflation.

just paying £26,244.93m now, and getting back £13,019.99m after 36 years, is a compound return of c. minus 1.93% per year.

the interest element is so low (initially c. 0.12%, but toward the end it would be close to 0.25% of the current value of the gilt), so it doesn't add much, hence the overall redemption yield is c. minus 1.79% - i.e. you get a return of about RPI minus 1.79%.

Glen_Clark

Reaper wrote: »

Are they? I hadn't heard of that. They buy a lot but I just assumed it was lazy, conservative investing.

I can tell my company pension to invest in one of a range of funds so I am not sure how that fits in.

Can you provide some info or links on their legal obligation to buy them?

If you google 'obliged to hold gilts' it comes up with a few links.
Of course I realise you are only guaranteed to lose half your money if you hold them till maturity. You may be able to offload them to some mug before then - like the long suffering British taxpayer when the BoE embarks on the next money printing spree.
Nevertheless, the negative coupon shows how severely distorted financial markets have become through QE.