Long gilts risk rating of 5??

zolou

Reviewing an Aviva pension plan, I notice that a significant part is in "Long Gilts" with a surprisingly (to me) high risk rating of 5. Presumably this was set up based on previous financial advice. I thought government bonds were one of the safest things to invest in, but on a scale of 1 to 7, 5 seems high. Can anyone shed any light on this?

http://www.fundslibrary.co.uk/fundslibrary.dataretrieval/documents.aspx/?user=ZCJdbT7i75uMreQ7PejSaRF1oS%2bDZqWLM1Onb8HYXn0%3d&type=packet_lp_fund_unit_doc_factsheet&Sedol=B101LK6&r=1

Prism

Long bonds of any type are very susceptible to interest rate rises. Imagine you had a fixed term bond or account paying 5% for the next 20 years. However if over the next 3-4 years the newly released rates when up to 6% then your bond drops in value (as people sell it on to buy the new ones). You might be looking at a 20%+ drop for a rise in interest rates of 1%.
The second the markets think that there is a chance of a rate rise (or fall), they sell out or buy into long bonds which makes the price quite volatile - hence the higher risk score. The higher risk is that at a time you might need your money back, the value of you fund might be significantly lower than you would like.

Linton

If you buy one £100 government bond now you know exactly how much interest you are going to get and that when the bond matures you will get the face value returned to you. So in a sense that is 100% safe barring the end of the world type scenarios.


However between now and then the capital value will change, often significantly. Looking at a list of bond prices I see that a £100 4.5% bond issued some years ago maturing in 2049 is currently worth about £180. In 2049 it will be worth £100. The high current value is because the effective interest rate as a % of price of this bond must match the interest rates available elsewhere, otherwise people would pay extra to buy them. When interest rates rise the value of this bond will fall, and vice versa. But of course interest rates cant fall much below what they are now.


I said single gilts are safe, but you arent investing in single gilts. You are investing in a gilt fund holding gilts with a wide range of maturity dates. So when you sell in a few years time most will be far from maturity. Who knows what the value will be, except it will probably be less than it is now.

bowlhead99

zolou wrote: »

Reviewing an Aviva pension plan, I notice that a significant part is in "Long Gilts" with a surprisingly (to me) high risk rating of 5. Presumably this was set up based on previous financial advice. I thought government bonds were one of the safest things to invest in, but on a scale of 1 to 7, 5 seems high. Can anyone shed any light on this?

http://www.fundslibrary.co.uk/fundslibrary.dataretrieval/documents.aspx/?user=ZCJdbT7i75uMreQ7PejSaRF1oS%2bDZqWLM1Onb8HYXn0%3d&type=packet_lp_fund_unit_doc_factsheet&Sedol=B101LK6&r=1

Can't follow your link as it's bespoke to you. But looking up the fund on Morningstar http://www.morningstar.co.uk/uk/snapshot/snapshot.aspx?id=VAUSA068H7&InvestmentType=SA you can see from the chart the value has shaken around a bit in recent years. The risk ratings are formulaic based on recent historic volatility, not just what the fund holds.

As others mentioned, gilts that don't mature for many years will be valued based on the inconvenience they are currently producing. The going rate for the bonds maturing in December 2040 and 2042 is about £160. They produce £4.25 and £4.50 income a year, respectively. In the current low interest rate environment some big institutions who need to put their money in something safe may think that £160 is a fair amount to pay for £4-4.50 every year until it matures at its £100 nominal value. However, if market interest rates rise and you can get bonds from blue chip companies and governments paying 4-5%, you might not want to pay much more than £100 for the bond. That's about a 40% loss if you just paid £160+ for it.

I am not suggesting this loss would happen overnight, just insight into why it is not going to be a risk 2 or 3 investment with bonds at current prices. The price changes every time there is a murmur about interest rates changing.

shinytop

I have some "over 15 year Gilts" holdings in my work pension. In one week in December 2018 the fund rose 8% then the week after fell 3%. That's more volatility than any equity-based funds I have. Hopefully when I come to transfer (soon) it will be on one of its ups.

zolou

Interesting - that all makes sense, thanks folks. I guess it gives scope for diversification from equities.

Thrugelmir

zolou wrote: »

Interesting - that all makes sense, thanks folks. I guess it gives scope for diversification from equities.

Even short dated 10 year gilts won't give you a return that beats inflation. Challenging times to be an investor.