Gilts Understanding

masonic

stone_circle said:

masonic said:  should not buy gilts with a duration greater than your investment horizon, as this exposes you to a likely capital loss. 

Care to expand? Capital loss as a result of bond price fluctuation? Because prices tend downwards towards par as they approach maturity? There's also upside potential AFAIK.

They always mature at par. If you buy for £108 today and the price is guaranteed to be £100 in 2028, then there is a very slim chance of the price being above £108 in a years time (most likely outcome is a reduction in returns over the whole period to maturity). You'd be gambling, and if inclined to do so, you'd have better odds buying a global equities tracker where the price rises over more periods than not. Neither is a sensible investment strategy.

stone_circle said:

Pls post anything in support of this. I have an iWeb account, and there's nothing on either their research or trading pages.

https://www.iweb-sharedealing.co.uk/help-and-guidance/investment-options.html

...

stone_circle

Thanks for that iWeb link. Yes capital will drop at a little over 1% per year ((£108 - £100) / 5 years), but sounds like it's relatively predictable. I can't understand why you'd conclude that investing in gilts is "gambling" to the same extent as investing in an equities tracker is, which is an asset class generally agreed to be higher volatility\risk than UK govt bonds. Even subtracting the capital loss, the returns beat savings accounts.

GeoffTF

OldScientist said:

You can buy individual gilts on iweb (I have done so), but have to do it by telephone (they contact the market maker directly and, in my relatively limited experience, the spread seems quite reasonable). £5 per transaction.

I traded some new style index linked gilts with iWeb a few days ago. They have to be traded over the telephone, but customer services told me that they can now trade many gilts online. I expect that the same is true for the Lloyds, Halifax and Bank of Scotland branded accounts.

masonic

stone_circle said:

Thanks for that iWeb link. Yes capital will drop at a little over 1% per year ((£108 - £100) / 5 years), but sounds like it's relatively predictable. I can't understand why you'd conclude that investing in gilts is "gambling" to the same extent as investing in an equities tracker is, which is an asset class generally agreed to be higher volatility\risk than UK govt bonds.

Investing in gilts isn't gambling. Investing and holding to maturity gives a guaranteed return. Likewise, investing in an equity tracker over the long term isn't gambling.

What is tantamount to gambling is the short term trading of either of these securities, such as holding a longer duration gilt for just a year, as you were suggesting in your earlier post. Gilts are a medium term investment, meaning that you should be holding to maturity or for at least 3-5 years if investing in longer durations. Otherwise the short term risk makes them too much of a gamble. I would recommend matching maturities to your investment horizon so as to avoid the capital fluctuations entirely.

stone_circle said:

Even subtracting the capital loss, the returns beat savings accounts.

This is clearly not true of the market leading savings accounts available today. Which is why I wouldn't invest in nominal gilts at the moment, though there have been times in the past when they have been more attractive vs savings. Money market funds are potentially a better alternative for money locked in an investment account if you need short term access to your capital.

spider42

Don't overlook the tax effects when evaluating gilts. Compared to fixed rate bonds, some of the short dated, low coupon gilts are very attractive at the moment, for those who are higher rate taxpayers and have already used their normal allowances (savings allowance, ISA allowances). This is because gilt capital gains are completely free of tax. Gilts with low coupons will trade at less than par, so there is a guaranteed tax-free capital gain, if held until maturity. The only tax liability is on the coupon itself, which is negligible on many gilts.

For example, the yield to maturity on TN25 is 4.65%. This has a coupon of only 0.125%, so the Income Tax on it is tiny. The offer price is currently £92.98, so almost all of the return is from the capital gain. Maturity date is 31/1/25. The internal rate of return, calculated using the coupon after 40% tax, is 4.6%. There is no further tax to pay. (I've ignored dealing costs in these figures, but these will be relatively trivial with a flat fee broker and a decent sized investment. E.g. a £10 dealing fee on a £10,000 investment would reduce the yield by about 0.007%. I've also used the quoted offer price, but in practice you would probably get it at less than the offer price, which would improve the effective yield).

The best 18 month fixed rate bond per Moneyfacts is paying 5.42%. So, ignoring tax, the fixed rate bond pays more than the gilt. But after 40% tax, you would only get 3.25% net with the fixed rate bond, compared to 4.6% net from the gilt. So the gilt is significantly better than a fixed rate bond, after tax.

aroominyork

@spider42 makes good points about tax benefits of gilts (and I hold TN25 for just that reason) but even in tax-wrapped SIPPs/ISAs they are attractive compared to hedged global aggregate bond funds which seem to be distributing under 3%.

masonic

aroominyork said:

@spider42 makes good points about tax benefits of gilts (and I hold TN25 for just that reason) but even in tax-wrapped SIPPs/ISAs they are attractive compared to hedged global aggregate bond funds which seem to be distributing under 3%.

You are not comparing like with like when comparing YTM of the gilt with yield of a fund (TN25's distributions are tiny compared with its forward capital gain). The effective YTM for the Bloomberg Global Aggregate Float Adjusted and Scaled Index (tracked by Vanguard and others) is 4.0% vs TN25's 4.65%. The reason this number is lower than for TN25 is that the fund buys debt securities across the yield curve and despite including higher yield corporate bonds, the inversion of the yield curve makes such a fund relatively unattractive compared with an individual short dated gilt, or indeed an ultra-short duration fund. In a SIPP or ISA, a money market fund could be an attractive alternative if you want an open-ended alternative that does not come with all the trading complexities of individual gilts. CSH2 is returning about 4.7% annualised at the moment looking at its gradient over the past month. The return will adjust (upward or downward) in line with the market, whereas individual gilts are useful to lock in a particular return if you fear interest rate policy is nearing a reversal (or to harvest that attractive tax exempt capital gain unwrapped if selecting the right issues).

aroominyork

masonic said:

aroominyork said:

@spider42 makes good points about tax benefits of gilts (and I hold TN25 for just that reason) but even in tax-wrapped SIPPs/ISAs they are attractive compared to hedged global aggregate bond funds which seem to be distributing under 3%.

You are not comparing like with like when comparing YTM of the gilt with yield of a fund (TN25's distributions are tiny compared with its forward capital gain). The effective YTM for the Bloomberg Global Aggregate Float Adjusted and Scaled Index (tracked by Vanguard and others) is 4.0% vs TN25's 4.65%. The reason this number is lower than for TN25 is that the fund buys debt securities across the yield curve and despite including higher yield corporate bonds, the inversion of the yield curve makes such a fund relatively unattractive compared with an individual short dated gilt, or indeed an ultra-short duration fund. In a SIPP or ISA, a money market fund could be an attractive alternative if you want an open-ended alternative that does not come with all the trading complexities of individual gilts. CSH2 is returning about 4.7% annualised at the moment looking at its gradient over the past month. The return will adjust (upward or downward) in line with the market, whereas individual gilts are useful to lock in a particular return if you fear interest rate policy is nearing a reversal (or to harvest that attractive tax exempt capital gain unwrapped if selecting the right issues).

I am a bit confused whether distribution yields are forward or backward looking. For example, AGGG's factsheet states a distribution yield of 1.70%. In line with your comment about the Bloomberg Aggregate it seems unlikely that is its actual distribution (and unlike a gilt there is no automatic capital gain other than what the market decides). Is the weighted average YTM of 3.66% a more accurate reflection of the fund's distributed income?

GeoffTF

aroominyork said:

masonic said:

aroominyork said:

@spider42 makes good points about tax benefits of gilts (and I hold TN25 for just that reason) but even in tax-wrapped SIPPs/ISAs they are attractive compared to hedged global aggregate bond funds which seem to be distributing under 3%.

You are not comparing like with like when comparing YTM of the gilt with yield of a fund (TN25's distributions are tiny compared with its forward capital gain). The effective YTM for the Bloomberg Global Aggregate Float Adjusted and Scaled Index (tracked by Vanguard and others) is 4.0% vs TN25's 4.65%. The reason this number is lower than for TN25 is that the fund buys debt securities across the yield curve and despite including higher yield corporate bonds, the inversion of the yield curve makes such a fund relatively unattractive compared with an individual short dated gilt, or indeed an ultra-short duration fund. In a SIPP or ISA, a money market fund could be an attractive alternative if you want an open-ended alternative that does not come with all the trading complexities of individual gilts. CSH2 is returning about 4.7% annualised at the moment looking at its gradient over the past month. The return will adjust (upward or downward) in line with the market, whereas individual gilts are useful to lock in a particular return if you fear interest rate policy is nearing a reversal (or to harvest that attractive tax exempt capital gain unwrapped if selecting the right issues).

I am a bit confused whether distribution yields are forward or backward looking. For example, AGGG's factsheet states a distribution yield of 1.70%. In line with your comment about the Bloomberg Aggregate it seems unlikely that is its actual distribution (and unlike a gilt there is no automatic capital gain other than what the market decides). Is the weighted average YTM of 3.66% a more accurate reflection of the fund's distributed income?

Of course it is. The Authorised Participants will ensure that the ETF trades at close to NAV, unless there is a big liquidity problem. The distribution yield is backward looking. It does not tell you anything about the likely return.

masonic

aroominyork said:

masonic said:

aroominyork said:

@spider42 makes good points about tax benefits of gilts (and I hold TN25 for just that reason) but even in tax-wrapped SIPPs/ISAs they are attractive compared to hedged global aggregate bond funds which seem to be distributing under 3%.

You are not comparing like with like when comparing YTM of the gilt with yield of a fund (TN25's distributions are tiny compared with its forward capital gain). The effective YTM for the Bloomberg Global Aggregate Float Adjusted and Scaled Index (tracked by Vanguard and others) is 4.0% vs TN25's 4.65%. The reason this number is lower than for TN25 is that the fund buys debt securities across the yield curve and despite including higher yield corporate bonds, the inversion of the yield curve makes such a fund relatively unattractive compared with an individual short dated gilt, or indeed an ultra-short duration fund. In a SIPP or ISA, a money market fund could be an attractive alternative if you want an open-ended alternative that does not come with all the trading complexities of individual gilts. CSH2 is returning about 4.7% annualised at the moment looking at its gradient over the past month. The return will adjust (upward or downward) in line with the market, whereas individual gilts are useful to lock in a particular return if you fear interest rate policy is nearing a reversal (or to harvest that attractive tax exempt capital gain unwrapped if selecting the right issues).

I am a bit confused whether distribution yields are forward or backward looking. For example, AGGG's factsheet states a distribution yield of 1.70%. In line with your comment about the Bloomberg Aggregate it seems unlikely that is its actual distribution (and unlike a gilt there is no automatic capital gain other than what the market decides). Is the weighted average YTM of 3.66% a more accurate reflection of the fund's distributed income?

A bond fund is just a portfolio of individual bonds that is replenished as holdings mature. There is a capital gain when bonds bought below par mature just as you would experience with something like TN25. YTM will account for this, so it isn't just income in that figure. Distribution yield is normally just past 12 month's income divided by current price, so is not particularly useful. Sometimes you will see it based on forward expected income, which is better, but still leaves out an important part of the underlying return.

The YTM will be accurate (defaults excepted) for the rundown of the current portfolio at that time. What is unknown is the fate of the proceeds when reinvested. You'd have the same issue when running your own bond ladder, except you would be in control of the reinvestment decisions.

For specifically intermediate or long duration funds, where each holding is sold a long time prior to maturity, then the market has much more influence on returns. Likewise if you sell your units, which you would have to do eventually, but over a long enough holding period, this unknown becomes insignificant.