Short duration, index linked bond funds, worth while holding?

TUVOK

Opinions please on holding this type of bond fund with rising inflation taking place.

masonic

I don't believe any short duration index linked gilt fund exists. Foreign index linked bonds won't be linked to UK inflation. You could buy individual index linked gilts, or accept those of longer duration in a fund. Taking a fund, the average YTM will be RPI - 2.5%, so you will not get full inflation protection. If inflation for 2022 comes out around the average of current predictions (4.3%) then you'd achieve a return of about 1.8%, less if interest rates go up (+/- 10% as gilts can be quite volatile). You could get a fixed term savings account paying about that. If inflation ends up higher, then you'd do slightly better. Shorter dated gilts have a more negative YTM, so would need even higher inflation to break even vs consumer savings.

Linton

To add a bit to Masonic's post - the reason why neither short nor long dated inflation linked bonds actually match inflation is that they are priced on the open market.  If inflation is expected to be, say, 3% people would be prepared to pay a lot extra to buy an inflation linked bond rather than a normal bond which may only return 1%.

The effect of market pressure is to ensure rhat, if the market's assumption on future inflation rates proves accurate, inflation linked bonds will return much the same as normal bonds.

GeoffTF

You will find the implied inflation here:

https://www.bankofengland.co.uk/statistics/yield-curves

Frankly it is horrifying. If the gilts market is right, we will be getting inflation rates approaching 5% over the next ten years or so. With an equity risk premium of about 3%, and gilts returning about 1.5%. we would expect equity returns of about 4.5%. The people who are hoping to beat inflation could be very disappointed.

JohnWinder

"It's my personal feeling that inflation is a medium-to-long-term problem and that you need medium-to-long-term protection.

In the short term, investors know what inflation is and can roughly guess what it will be like in the next year or so... and if they are wrong, two years of inflation being 5% more than they expected means they will end up with 10% less buying power than they had counted on. Not great but not a catastrophe. During the last big period of inflation, it was uncomfortable and unsettling because bank interest rates and salaries and so forth lagged inflation, but they did go up with inflation.

The real problem comes when you have a normal yield curve, and you'd like to take advantage of higher interest rates being paid on ten- or twenty-year bonds, but you are worried about how much unexpected inflation might occur over that long a period of time.

So I honestly don't see the point of short-term TIPS because short-term bond and cashlike investments will take care of themselves well enough--maybe not optimally, but I'm "a satisficer, not an optimizer." So I hold an average-intermediate-term TIPS fund just as I hold an average-intermediate-term nominal bond fund. "

https://www.bogleheads.org/forum/viewtopic.php?t=360498

masonic

Ok, but TIPS with shorter duration give exactly the same inflation protection as those with longer maturities, as pointed out in that thread. The difference is the interest rate sensitivity and increased premium you would have to pay on the shorter dated ones.

GeoffTF

Deleted_User said:

I think it's wrong to interpret this implied inflation as the "wisdom of the crowd" best estimate of what inflation will be. Many holders of gilts (especially pension funds) are prepared to pay a premium to get index-linked returns. Pensions managed according to "liability matching" may effectively be indifferent about how large the premium is, and will hold index-linked gilts regardless. This would suggest that the crowd's/market's true estimate of future inflation is actually lower.

Index linked Gilts are not part of the Quantitative Easing programme. The Bank of England regularly issues new IL gilts to ensure that there is a sufficient supply for pensions. There is a free market in IL gilts. There is no reason to believe that IL gilt prices are not "the wisdom of the crowd". Nonetheless, "the crowd" does not know the future, and does not always get it right. IL gilt prices spiked recently in an inflation scare, but have since subsided a little. Currently, I believe that you do pay a small premium for IL gilts, because they are the only safe way of protecting against inflation.

Linton

GeoffTF said:

Deleted_User said:

I think it's wrong to interpret this implied inflation as the "wisdom of the crowd" best estimate of what inflation will be. Many holders of gilts (especially pension funds) are prepared to pay a premium to get index-linked returns. Pensions managed according to "liability matching" may effectively be indifferent about how large the premium is, and will hold index-linked gilts regardless. This would suggest that the crowd's/market's true estimate of future inflation is actually lower.

Index linked Gilts are not part of the Quantitative Easing programme. The Bank of England regularly issues new IL gilts to ensure that there is a sufficient supply for pensions. There is a free market in IL gilts. There is no reason to believe that IL gilt prices are not "the wisdom of the crowd". Nonetheless, "the crowd" does not know the future, and does not always get it right. IL gilt prices spiked recently in an inflation scare, but have since subsided a little. Currently, I believe that you do pay a small premium for IL gilts, because they are the only safe way of protecting against inflation.

At current prices IL Gilts are pretty much guaranteed to return less than inflation if you hold them to maturity.  If you dont hold them to maturity their prices are very volatile so you could gain or lose more than inflation.  Over the past 3 months the highest value of a 40 year IL gilt is some 15% higher than the lowest.   This is three times the range of of an MSCI World equity index tracker over the same period.  Not the sort of behaviour one expects from a bond.

GeoffTF

Linton said:

GeoffTF said:

Deleted_User said:

I think it's wrong to interpret this implied inflation as the "wisdom of the crowd" best estimate of what inflation will be. Many holders of gilts (especially pension funds) are prepared to pay a premium to get index-linked returns. Pensions managed according to "liability matching" may effectively be indifferent about how large the premium is, and will hold index-linked gilts regardless. This would suggest that the crowd's/market's true estimate of future inflation is actually lower.

Index linked Gilts are not part of the Quantitative Easing programme. The Bank of England regularly issues new IL gilts to ensure that there is a sufficient supply for pensions. There is a free market in IL gilts. There is no reason to believe that IL gilt prices are not "the wisdom of the crowd". Nonetheless, "the crowd" does not know the future, and does not always get it right. IL gilt prices spiked recently in an inflation scare, but have since subsided a little. Currently, I believe that you do pay a small premium for IL gilts, because they are the only safe way of protecting against inflation.

At current prices IL Gilts are pretty much guaranteed to return less than inflation if you hold them to maturity.  If you dont hold them to maturity their prices are very volatile so you could gain or lose more than inflation.  Over the past 3 months the highest value of a 40 year IL gilt is some 15% higher than the lowest.   This is three times the range of of an MSCI World equity index tracker over the same period.  Not the sort of behaviour one expects from a bond.

If you need a guaranteed inflation linked sum in the future (e.g. to pay your bills) that is price for that you have to pay. I have a relative who is about to retire on full state pension. He also has a defined contribution pension. He is buying an index linked annuity to generate another £3K or so. That is the difference between surviving and having a comfortable income. He would be mad to gamble that away with draw down. If he was funding luxuries, that would be a different matter. He could afford to take a risk, in that case.

Long dated bonds can be very volatile. If you have a liability at maturity, that does not matter. If you want to protect against deflation (with a conventional bond), that volatility is what you want.