Buy Capital Gearing Trust?

anonmoose

Thank you Albermarle much appreciated.

aroominyork

masonic said:

aroominyork said:

Sorry - I must have been playing the B side. Walk me through this in baby steps if you have the patience, please. Is the derivative the cost of the hedging, and is there any link to future UK inflation other than not wanting TIPS proceeds not to be eaten up by forex/derivative costs? Also, since overseas bonds are usually hedged (eg at least 80% of them to qualify as a strategic bond fund) are you saying you are happy to have a play on a continually weakening Sterling?

I'm still a bit hazy about exactly why CGT/PNL do not hedge. Maybe you can direct me to your previously posted playlist?

My last performance was here, with an exchange between us going just over onto the following page. There have been several others, which, if not for the want of a decent search facility, I'd have been happy to provide. In short, if you start from the principle that a weakening currency leads to goods and services tending to become more expensive in local currency, then the corollary is that a weakening currency is somewhat inflationary. You then turn to foreign assets, such as equities, bonds, etc, and you find those go up in price as your currency weakens and your local inflation is relatively higher. In the special case of foreign index linked assets, you get the benefit of foreign inflation protection in foreign currency. Substitute in your inflationary weakening exchange rate, and you tend to get an extra element to the linking that brings you closer to local inflation protection, albeit with somewhat more volatility. Hedge your foreign index linked assets to home currency, and you smooth the ride, but remove the ability of those foreign assets to protect from excess local inflation. That's in addition to the drag on performance that the cost of hedging will impart.

Why CGT/PNL do not hedge their index linked assets (or nominal ones) is not a question for me, and I don't know if they have hedged in the past or would do so in the future. I would guess that they don't hedge because they don't see it as beneficial to medium or long term returns.

Many thanks. I guess my brain was not ready to absorb your previous post at the time. I will spend a little time working through how the three options you described - hedged TIPS, unhedged TIPS, index-linked gilts - would play out over various scenarios, though on first reading I see why unhedged TIPS are the best best (as do CGT/PNL). Perhaps I have made a rookie error in buying Royal London Short Duration Global Index Linked Bond a few months ago; it has fallen a little while unhedged short duration TIPS have shot up. Looking back over five years they have diverged and then converged, so I need to consider whether to switch now. Any thoughts?

masonic

aroominyork said:

masonic said:

aroominyork said:

Sorry - I must have been playing the B side. Walk me through this in baby steps if you have the patience, please. Is the derivative the cost of the hedging, and is there any link to future UK inflation other than not wanting TIPS proceeds not to be eaten up by forex/derivative costs? Also, since overseas bonds are usually hedged (eg at least 80% of them to qualify as a strategic bond fund) are you saying you are happy to have a play on a continually weakening Sterling?

I'm still a bit hazy about exactly why CGT/PNL do not hedge. Maybe you can direct me to your previously posted playlist?

My last performance was here, with an exchange between us going just over onto the following page. There have been several others, which, if not for the want of a decent search facility, I'd have been happy to provide. In short, if you start from the principle that a weakening currency leads to goods and services tending to become more expensive in local currency, then the corollary is that a weakening currency is somewhat inflationary. You then turn to foreign assets, such as equities, bonds, etc, and you find those go up in price as your currency weakens and your local inflation is relatively higher. In the special case of foreign index linked assets, you get the benefit of foreign inflation protection in foreign currency. Substitute in your inflationary weakening exchange rate, and you tend to get an extra element to the linking that brings you closer to local inflation protection, albeit with somewhat more volatility. Hedge your foreign index linked assets to home currency, and you smooth the ride, but remove the ability of those foreign assets to protect from excess local inflation. That's in addition to the drag on performance that the cost of hedging will impart.

Why CGT/PNL do not hedge their index linked assets (or nominal ones) is not a question for me, and I don't know if they have hedged in the past or would do so in the future. I would guess that they don't hedge because they don't see it as beneficial to medium or long term returns.

Many thanks. I guess my brain was not ready to absorb your previous post at the time. I will spend a little time working through how the three options you described - hedged TIPS, unhedged TIPS, index-linked gilts - would play out over various scenarios, though on first reading I see why unhedged TIPS are the best best (as do CGT/PNL). Perhaps I have made a rookie error in buying Royal London Short Duration Global Index Linked Bond a few months ago; it has fallen a little while unhedged short duration TIPS have shot up. Looking back over five years they have diverged and then converged, so I need to consider whether to switch now. Any thoughts?

There's still a question as to how much hedging is employed in that fund. The investment policy states "At least 70% of these investments will be made in the UK, North America and Europe, and will be sterling-denominated orhedged back to sterling". They've invested 30% in index linked gilts, so a further 40% of the non-UK bonds must be hedged. Up to 30% could be unhedged. It's not a fund I've had an interest in, so I don't know what they are doing in practice, or whether altering the amount of hedging (and currencies hedged back to sterling) is part of the active management of the fund.

As for what to do, well it depends. A favourable scenario for the hedged global fund is if the pound ends its secular decline and strengthens, and/or if inflation in the UK comes down while it persists in the US and elsewhere. I don't see either of those as being anywhere near likely, quite the opposite. But if you wanted to hedge your bets, you could have some hedged and some unhedged - hedging your hedging. This is effectively where you've ended up unwittingly. That just comes with the caveat that the "index linking" is more of a bet on other countries' inflation figures, rather than inflation here in the UK.

Personally, I'm longing for the days when I can hold a long dated nominal gilt fund again and keep things simple.

aroominyork

masonic said:

aroominyork said:

masonic said:

aroominyork said:

Sorry - I must have been playing the B side. Walk me through this in baby steps if you have the patience, please. Is the derivative the cost of the hedging, and is there any link to future UK inflation other than not wanting TIPS proceeds not to be eaten up by forex/derivative costs? Also, since overseas bonds are usually hedged (eg at least 80% of them to qualify as a strategic bond fund) are you saying you are happy to have a play on a continually weakening Sterling?

I'm still a bit hazy about exactly why CGT/PNL do not hedge. Maybe you can direct me to your previously posted playlist?

My last performance was here, with an exchange between us going just over onto the following page. There have been several others, which, if not for the want of a decent search facility, I'd have been happy to provide. In short, if you start from the principle that a weakening currency leads to goods and services tending to become more expensive in local currency, then the corollary is that a weakening currency is somewhat inflationary. You then turn to foreign assets, such as equities, bonds, etc, and you find those go up in price as your currency weakens and your local inflation is relatively higher. In the special case of foreign index linked assets, you get the benefit of foreign inflation protection in foreign currency. Substitute in your inflationary weakening exchange rate, and you tend to get an extra element to the linking that brings you closer to local inflation protection, albeit with somewhat more volatility. Hedge your foreign index linked assets to home currency, and you smooth the ride, but remove the ability of those foreign assets to protect from excess local inflation. That's in addition to the drag on performance that the cost of hedging will impart.

Why CGT/PNL do not hedge their index linked assets (or nominal ones) is not a question for me, and I don't know if they have hedged in the past or would do so in the future. I would guess that they don't hedge because they don't see it as beneficial to medium or long term returns.

Many thanks. I guess my brain was not ready to absorb your previous post at the time. I will spend a little time working through how the three options you described - hedged TIPS, unhedged TIPS, index-linked gilts - would play out over various scenarios, though on first reading I see why unhedged TIPS are the best best (as do CGT/PNL). Perhaps I have made a rookie error in buying Royal London Short Duration Global Index Linked Bond a few months ago; it has fallen a little while unhedged short duration TIPS have shot up. Looking back over five years they have diverged and then converged, so I need to consider whether to switch now. Any thoughts?

That just comes with the caveat that the "index linking" is more of a bet on other countries' inflation figures, rather than inflation here in the UK.

Given that a fair part of current inflation results from global events, I am not too worried about international inflation diverging massively from UK inflation. This is not a retirement income portfolio that needs to cover monthly bills. Also, as we have often mused, there is no short duration index-linked gilts fund (and I do not want to buy individual bonds).

masonic

aroominyork said:

masonic said:

aroominyork said:

masonic said:

aroominyork said:

Sorry - I must have been playing the B side. Walk me through this in baby steps if you have the patience, please. Is the derivative the cost of the hedging, and is there any link to future UK inflation other than not wanting TIPS proceeds not to be eaten up by forex/derivative costs? Also, since overseas bonds are usually hedged (eg at least 80% of them to qualify as a strategic bond fund) are you saying you are happy to have a play on a continually weakening Sterling?

I'm still a bit hazy about exactly why CGT/PNL do not hedge. Maybe you can direct me to your previously posted playlist?

My last performance was here, with an exchange between us going just over onto the following page. There have been several others, which, if not for the want of a decent search facility, I'd have been happy to provide. In short, if you start from the principle that a weakening currency leads to goods and services tending to become more expensive in local currency, then the corollary is that a weakening currency is somewhat inflationary. You then turn to foreign assets, such as equities, bonds, etc, and you find those go up in price as your currency weakens and your local inflation is relatively higher. In the special case of foreign index linked assets, you get the benefit of foreign inflation protection in foreign currency. Substitute in your inflationary weakening exchange rate, and you tend to get an extra element to the linking that brings you closer to local inflation protection, albeit with somewhat more volatility. Hedge your foreign index linked assets to home currency, and you smooth the ride, but remove the ability of those foreign assets to protect from excess local inflation. That's in addition to the drag on performance that the cost of hedging will impart.

Why CGT/PNL do not hedge their index linked assets (or nominal ones) is not a question for me, and I don't know if they have hedged in the past or would do so in the future. I would guess that they don't hedge because they don't see it as beneficial to medium or long term returns.

Many thanks. I guess my brain was not ready to absorb your previous post at the time. I will spend a little time working through how the three options you described - hedged TIPS, unhedged TIPS, index-linked gilts - would play out over various scenarios, though on first reading I see why unhedged TIPS are the best best (as do CGT/PNL). Perhaps I have made a rookie error in buying Royal London Short Duration Global Index Linked Bond a few months ago; it has fallen a little while unhedged short duration TIPS have shot up. Looking back over five years they have diverged and then converged, so I need to consider whether to switch now. Any thoughts?

That just comes with the caveat that the "index linking" is more of a bet on other countries' inflation figures, rather than inflation here in the UK.

Given that a fair part of current inflation results from global events, I am not too worried about international inflation diverging massively from UK inflation. This is not a retirement income portfolio that needs to cover monthly bills. Also, as we have often mused, there is no short duration index-linked gilts fund (and I do not want to buy individual bonds).

I hope you're right, but I'm much more of a pessimist. I think the US is at a huge advantage, and that the UK and mainland Europe are in for some really tough times over the next few years.

masonic

Very timely upload from PensionCraft discussing all the things that make me nervous about UK inflation...

https://www.youtube.com/watch?v=GCLBS6zt_K8

ChilliBob

masonic said:

Very timely upload from PensionCraft discussing all the things that make me nervous about UK inflation...

https://www.youtube.com/watch?v=GCLBS6zt_K8

Isn't very positive news is it! Admittidly I only watched about 2/3rds through as I got distracted by my nipper

aroominyork

So I have thought this through at a very simplified level.

 

Three investment options: unhedged TIPS, hedged TIPS, I/L gilts.

Two scenarios: higher inflation in US than UK; higher inflation in UK than US.

 

Unhedged TIPS + higher US inflation. Good TIPS return and weak dollar. Moderate return

Unhedged TIPS + higher UK inflation. Low TIPS return and strong dollar. Moderate return

 

Hedged TIPS + higher US inflation. Good TIPS return and no forex impact. Excellent return

Hedged TIPS + higher UK inflation. Low TIPS return and no forex impact. Poor return

 

I/L gilts + higher US inflation. Low TIPS return and no forex impact. Relative poor return

I/L gilts + higher UK inflation. Good TIPS return and no forex impact. Relative good return

 

Corrections and views please!

Edited to strikeout TIPS following masonic's comment (poor proofreading!) and add Relative. Assume all investments are short duration.

masonic

Yes, broadly that's how I'd characterise the 4 x TIPS scenarios. For the I/L gilts, you might have made a copy/paste error as you mention TIPS. For a given UK rate of inflation the return would obviously be the same regardless of what is going on in the US. I'd have said both moderate - but this ignores the duration issue.

The alternative way to look at it is to think of the real return in the UK context. For this the unhedged TIPS would be somewhat negative; hedged TIPS could be anything from somewhat positive to significantly negative; I/L gilts would be somewhat negative (but with greater interest rate sensitivity than TIPS due to their duration). Needless to say a positive real return is a high bar.

JohnWinder

Be careful with ‘unhedged - moderate return’. You’re assuming the currency movement won’t swamp the difference between your country’s inflation and the other’s bonds’ protection. But 10-15% changes in exchange rate occur over several months.
Secondly, you’ve omitted the condition ‘higher UK inflation, weaker dollar’ which would be a ‘fail’ for inflation protection. It is the condition you might expect, with UK inflation causing higher UK interest rates which causes the currency to rise. What have I missed?
CGT aims to preserve shareholder real wealth, and increase it ie, maintain price compared to inflation, and grow. Some assets that protect against inflation are stocks, real estate, long term bonds and others no doubt, but they all do it against a backdrop of substantial volatility. The benefit you get over inflation with stocks is about 6%/year on average, but the standard deviation is about 12%; it’s a wild ride. For long term bonds it’s about 4%/year and 11% thrashing around. Gold is worse, in both dimensions. None seem suited to CGT's aim.
The only way to get certain inflation protection, without price variation, is with short term inflation linked bonds when their yield is positive which they still aren’t. Another unsuitable asset type. What to do?
Add currency flux to an impossible mix? There’s a hint of medieval alchemy about trying to turn impossible ingredients into a golden output.