Buy Capital Gearing Trust?

masonic

JohnWinder said:

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.

Presumably, this would be the scenario if central banks slammed monetary policy into reverse gear to stave off a deep recession, and we had another race to the bottom for currencies. A possible scenario where capital growth would be expected across asset classes. If the US goes it alone, then you'd expect to see a substantial weakening of the dollar, giving some forex-based growth, although that seems the least likely of all outcomes. Some have remarked that USD is to be replaced as the global reserve currency and that a rising China could do that, but this seems quite unlikely in the short term.

JohnWinder said:

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.

This is a scenario where the individually held short-dated I/L gilt would be the best of a bad bunch. Perhaps a return to the 1970s of worse. High unemployment, people losing their homes, property crash, a deep and prolonged recession. It would take a particularly callous central bank to raise rates into oblivion, but who knows? The objective here would perhaps be to limit the haemorrhage of value from the low risk assets as much as possible, while rebalancing into cheap risk assets (for those who have a time horizon long enough to benefit from an eventual recovery).

JohnWinder said:

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.

I've remarked elsewhere that I have my doubts CGT will beat inflation over the next few years if inflation estimates are right. I'd be very happy with inflation minus a couple of percent (which is achievable through short dated I/L gilts).

aroominyork

masonic said:

I've remarked elsewhere that I have my doubts CGT will beat inflation over the next few years if inflation estimates are right. I'd be very happy with inflation minus a couple of percent (which is achievable through short dated I/L gilts).

Is it right to calculate, for example, Treasury 0.125% Index-Linked 2026 (TR26) trading at a buy price of £108.60 and maturing on 22 March 2026. Say for simplicity there are four years to maturity, the amount you would undershoot inflation would be (8.60/4) – 0.125 = 2.025% a year?

masonic

aroominyork said:

masonic said:

I've remarked elsewhere that I have my doubts CGT will beat inflation over the next few years if inflation estimates are right. I'd be very happy with inflation minus a couple of percent (which is achievable through short dated I/L gilts).

Is it right to calculate, for example, Treasury 0.125% Index-Linked 2026 (TR26) trading at a buy price of £108.60 and maturing on 22 March 2026. Say for simplicity there are four years to maturity, the amount you would undershoot inflation would be (8.60/4) – 0.125 = 2.025% a year?

No, that's not correct, because the coupon and principal will have been index linked. It will not redeem at £100 and the coupon will no longer be 0.125% pa per £100 nominal. To find the redemption payment, you'd need to look at the prospectus to find the base RPI figure used for the bond, and then use this and the current RPI figure to determine the current par value of the bond. The coupon is also index linked, so you could either use the current par value or perform the same scaling calculation for income. When armed with both of these values, you can perform your calculation above to get an approximate answer in today's money. There is a guide and worked examples here: https://www.dmo.gov.uk/publications/gilt-market/formulae-and-examples/ (see "Method for calculating cash flows on index-linked gilts"), and the prospectus is here: https://www.dmo.gov.uk/media/15313/prosp160118.pdf

I tend to use http://www.wolfbane.com/rpi.htm for RPI index figures.

Linton

masonic said:

aroominyork said:

masonic said:

I've remarked elsewhere that I have my doubts CGT will beat inflation over the next few years if inflation estimates are right. I'd be very happy with inflation minus a couple of percent (which is achievable through short dated I/L gilts).

Is it right to calculate, for example, Treasury 0.125% Index-Linked 2026 (TR26) trading at a buy price of £108.60 and maturing on 22 March 2026. Say for simplicity there are four years to maturity, the amount you would undershoot inflation would be (8.60/4) – 0.125 = 2.025% a year?

No, that's not correct, because the coupon and principal will have been index linked. It will not redeem at £100 and the coupon will no longer be 0.125% pa per £100 nominal. To find the redemption payment, you'd need to look at the prospectus to find the base RPI figure used for the bond, and then use this and the current RPI figure to determine the current par value of the bond. The coupon is also index linked, so you could either use the current par value or perform the same scaling calculation for income. When armed with both of these values, you can perform your calculation above to get an approximate answer in today's money. There is a guide and worked examples here: https://www.dmo.gov.uk/publications/gilt-market/formulae-and-examples/ (see "Method for calculating cash flows on index-linked gilts"), and the prospectus is here: https://www.dmo.gov.uk/media/15313/prosp160118.pdf

I tend to use http://www.wolfbane.com/rpi.htm for RPI index figures.

I am confused.  This particular bond was issued in 2014, presumably with a nominal value of £100.  The current par value is very approximately £100 X (RPI May2022)/(RPI May2014)=£100 X 1330/1010= £132.  What does the current published price of £108.060 mean?  It cant imply an >18% gain in 2 years.

EDIT: It's 4 years, not 2 years.  But the current 5 year gilt rate is 1.8% (nearest to 4 years I can get).  4 years at 1.8%=7% which is much less than the 18% estimated for the IL bonds.

masonic

Linton said:

masonic said:

aroominyork said:

masonic said:

I've remarked elsewhere that I have my doubts CGT will beat inflation over the next few years if inflation estimates are right. I'd be very happy with inflation minus a couple of percent (which is achievable through short dated I/L gilts).

Is it right to calculate, for example, Treasury 0.125% Index-Linked 2026 (TR26) trading at a buy price of £108.60 and maturing on 22 March 2026. Say for simplicity there are four years to maturity, the amount you would undershoot inflation would be (8.60/4) – 0.125 = 2.025% a year?

No, that's not correct, because the coupon and principal will have been index linked. It will not redeem at £100 and the coupon will no longer be 0.125% pa per £100 nominal. To find the redemption payment, you'd need to look at the prospectus to find the base RPI figure used for the bond, and then use this and the current RPI figure to determine the current par value of the bond. The coupon is also index linked, so you could either use the current par value or perform the same scaling calculation for income. When armed with both of these values, you can perform your calculation above to get an approximate answer in today's money. There is a guide and worked examples here: https://www.dmo.gov.uk/publications/gilt-market/formulae-and-examples/ (see "Method for calculating cash flows on index-linked gilts"), and the prospectus is here: https://www.dmo.gov.uk/media/15313/prosp160118.pdf

I tend to use http://www.wolfbane.com/rpi.htm for RPI index figures.

I am confused.  This particular bond was issued in 2014, presumably with a nominal value of £100.  The current par value is very approximately £100 X (RPI May2022)/(RPI May2014)=£100 X 1330/1010= £132.  What does the current published price of £108.060 mean?  It cant imply an >18% gain in 2 years.

I don't think that price could represent the actual consideration you'd pay if trading the bond. I have some vague recollection of someone else mentioning that the prices quoted in various places have been adjusted to remove the index linking, so they had a shock when they actually came to buy and were quoted a lot more! If £108.60 represents the current nominal price, which seems likely, then it can be simply treated as being at an 8.6% premium, and only the coupons need adjusting for inflation.

The bond uses the reference index date of 16th July 2015 according to the prospectus, so the current index ratio is 1.304 (roughly, as I haven't bothered with the minor 3-month lag adjustments), making the inflation adjusted annual coupon 0.163% and running yield 0.150%. Plugging these into aroominyork's crude calculation gives RPI-2.00% for YTM, which seems about right.

£100 of nominal bond would actually cost you £141.61 (£108.6 x 1.304), but you would actually get that back minus the 8.6% premium at maturity, with some more index linking. Pricing this way seems confusing to me - why not just use the actual price you pay? - but even the trades at London Stock Exchange seem to use this non-indexed price.

MK62

I seem to recall reading that the pricing is done this way to allow quick and easy price comparison with conventional gilts......

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?

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.

Yes, it is indeed where I unwittingly am! My unhedged index-linked bond element of CGT comprises about double my hedged Royal London Short Duration Global Index Linked Bond. That feels comfortable. I am also moving away from the idea of PNL: I want to increase WP from c.15% to 20+% of my portfolio and although in my mind I figured I would diversify from CGT once I got past 20%, PNL doesn't feel logical: I get similar bonds in both funds; CGT's equities give me some value to balance my PNL-like Fundsmith holding; the gold would be <1% of my portfolio so is immaterial. If I decide I want some gold to replace corporate bonds, I should buy a meaningful amount - say 5%.