Index Linked

Altior

I'd like to feel I'm fluent with investing, and have a reasonable grasp of the basics at least. 

My workplace pension I'm contributing to is tied to Royal London alas, so I'm stuck with the fund ranges they offer. Their own funds, and a limited range from other providers. 

One of their own funds is the RLP Index Linked Pension Fund. This has history going back decades, so a number of cycles. 

In the last six months the price has dropped from 1190 to 912. Wow!

I'm reasonably tempted to get involved in this now. Can anyone rationalise the very significant fall in price, when inflation expectations are being regularly superseded. I realise that sterling has been rapidly dropping vs USD (along with many currencies), and there may be significant outflows from the fund. However, for a fund that holds bonds that are protected against inflation, I can't quite put my finger on the reason for the large sell off. Sterling has been debased, but that hasn't just happened in the last 6 months. It should be seeing some very reasonable income over the next year at least.

Gary1984

Index linked gilt prices are largely by future inflation and interest rate expectations. Increasing inflation increases prices but increasing interest rates decreases prices, and we've had both recently.

So looks like the interest rates are having a larger impact than the inflation. Perhaps because the increase to interest rates is expected to be permanent whereas inflation is mostly caused by supply chain issues and an energy shock so should be shorter lived?

[Deleted User]

A lot depends on duration. Long duration = big hit when rates go up. 

JohnWinder

I'm reasonably tempted to get involved in this now.

Management fee of 1%/year, for a fund that might return 3%/year, yuk. There aren't similar others, cheaper?

dunstonh

I can't quite put my finger on the reason for the large sell off. 

It is well documented.

Management fee of 1%/year, for a fund that might return 3%/year, yuk. There aren't similar others, cheaper?

What makes you think it is 1%?   The OP says it is a workplace pension.  So, it can't be.    By the time you add in fund based discounts, it could be around 0.4%.

JohnWinder

Thanks. I followed the link from Altior where it said: Net expense ratio.........1.00%

Altior

I get that inflation hits gilts, but in August 2019, the fund touched 1200. This was obviously way before anyone considered double digit inflation. So if you gambled and bought this fund back then, you should be laughing (in theory) as inflation is a factor of at least five times expectation. Where's the gain? I was always told that you will only benefit from index linked gilts if inflation supersedes expectation, which it has in a big way.

Yes base rates have shifted, but not exceptionally, not yet anyway. I don't think anyone is forecasting double digit central rates.

It's almost like this fund has reacted inversely to what should have happened as inflation has spiked. I try to be a contrarian investor on occasion, and go against the flow, which is why this is tempting me. I also feel like inflation will be sticky, and we won't be seeing the 2% target in the near future. 

With regard to the fees, yes I'm tied to the offerings of RL for the workplace pension, sadly. We get a 0.5% reduction if we buy RL funds, as part of the employer arrangement. 

Gary1984

Base rates have nothing to do with the price of gilts. The price is determined by interest rates in the market which have increased significantly at long durations. Inflation expectations at long durations won't have changed all that much as the inflation issue is expected to be shorter term. That's why interest rates are pulling the price down more than inflation is pushing it up.

Altior

Cheers Gary, obviously base rates lead interest rates. The point I'm trying to nail here is the index linked element. This fund has reacted like I would expect a long duration gilt fund to react. 

If I bought a linked gilt for £1K, when inflation was 2%, I would expect someone to offer me more for it when inflation was 10% (as the income is much more), than if it was a fixed income bond at 2%. It's very unlikely to go from 10% to 2% within a year. Essentially I would expect a divergence between the two types of fund, standard long and index linked. As the linked one offers the exact protection (insurance) you need when inflation escalates unexpectedly. I'm open to learning as we never stop doing that!

biscan25

I can tie this up reasonably if I assume the duration and inflation sensitivity is 15 years (in the absence of the actual figures)

From the bank of England yield curves:

15 year nominal gilt rates: End Feb 1.65%, end August 3.29%
15 year breakeven inflation: End Feb 4.13%, end August 3.93%

So 1190 * (1.0165/1.0329)^15 * (1.0393/1.0413) ^15 = 949

The point is that nominal rates have gone up, which drives down the price of gilts both conventional and index-linked, and long term inflation expectations have not changed by much (they've gone down slightly over this time period).

[Deleted User]

Looking at the holdings, 15 year average duration seems about right https://www.trustnet.com/factsheets/P/so13/rlp-index-linked-pn/

The other part of the equation is Mr Market. If 6 months ago everyone in the UK wanted inflation protection and rushed into buying linkers, the prices would have jumped. People who sold then would have enjoyed a handsome profit and people who bought paid a premium.  Now the sentiment has changed, hence the losses.

I hold US TIPs (bought 2 years ago) and haven’t observed such sharp movements. In fact, if you count in GBP, year to date my US TIPs returned +9%. They have effective duration of 7 years vs 15 so that helped but UK must have had a bit of a boom in linkers a few months back which wasn’t observed in the US. 

Buying linkers you are paying a premium over standard gilts to reflect expected inflation.  Mr Market’s Inflation expectations 6 months ago must have been higher than today (remember we are talking over the period of bond duration).