Gilts as Fixed Savings Proxy - Probably too late!

ChilliBob

Guys,

I had a rough look yesterday and I'm pretty sure the savings interest I'll generate will create a basic rate tax liability - so, 20%. 

This made me return to something discussed, in theory, a couple of times on here, and look at it more practically. 

So, with this in mind I set about:

1. Comparing gilts with 6 month, 1 year, 18 month, 2 year fixed savings rates, with 20% deducted.
2. Finding gilts with very low coupons - as tax would be liable on these, yet not on the capital gain

Finding this prime example, TN24.
https://www.ii.co.uk/bonds/united-kingdom-0125-31012024/LSE:TN24

From what I can see it's basically:
Very small coupon
Difference from current price vs the rack rate of £100, would produce a return of around 2.88%.. round to 2.9% to include the coupon etc.

This is essentially a 1 year fixed comparison, so, say 4.2% is the best fix you could get (from some more well known names like Paragon, etc). Take 20% off this and you've got 3.36% return net. So, even with the tax implications it seems better to stick with fixed term savings instead of gilts.

Should the price of the gilt drop to say 96.5 or so then it's a similar comparison.

For some reason others, like TN25, can't be found on II, which seems a bit odd.

I'm sure there's been some others who have looked into this, so, keen to know if I've messed anything up in the above, or should consider something else to achieve a certain/highly likely return in this scenario.

masonic

Based on the closing price, TN24 has a YTM of 3.58%. so a little above a 1 year fix for a BR taxpayer above their PSA, but not enough to swing it for most people. There was a window of opportunity when using individual gilts could lock in a higher return than fixed term savings, but currently the best use would be in S&S ISAs or SIPPs where someone wishes to hold cash or cash equivalents.

Availability for trading seems to vary, perhaps according to current liquidity. Some can only be traded by phone. Index linked gilts are probably the more interesting investment currently if you are concerned that there will be a long tail or resergence of this current bout of inflation.

GeoffTF

You can get the redemption yields (real redemption yields for index linked) here:

https://reports.tradeweb.com/account/login/

Yes, low coupon gilts are attractive, particularly for higher rate tax payers. Most of the gilt trade is on the wholesale market where there is lots of liquidity and the spreads are very narrow. I buy 0.125% new style index linked gilts over the phone. The spreads are not good for retail investors, but it is worthwhile nonetheless. As with everything, do your homework first:

https://www.dmo.gov.uk/responsibilities/gilt-market/

ChilliBob

masonic said:

Based on the closing price, TN24 has a YTM of 3.58%. so a little above a 1 year fix for a BR taxpayer above their PSA, but not enough to swing it for most people. There was a window of opportunity when using individual gilts could lock in a higher return than fixed term savings, but currently the best use would be in S&S ISAs or SIPPs where someone wishes to hold cash or cash equivalents.

Availability for trading seems to vary, perhaps according to current liquidity. Some can only be traded by phone. Index linked gilts are probably the more interesting investment currently if you are concerned that there will be a long tail or resergence of this current bout of inflation.

That's interesting, thanks Masonic. Yeah, the closing price was about break even where it just starts to make sense. 

I tried to follow on about linkers in my own simplicity thread, which ironically got complex due to linkers hijacking (which I found interesting, no dig at anyone!). 

I tried to look into it further a bit and it seemed the break even rate of inflation was a key element to it, which I couldn't seem to find and fully get my head around. 

I'd still be interested in this, as at the moment I'll have a decent chunk liable for 20% tax. If I could reduce the savings to avoid this I could save 3-4k.

By the time I try round to fully understanding it in sure it would be too late. As it is I did see the analogy that investing into linkers in a time of high inflation was like buying house insurance when your house is burning down - a little late.

Whilst nobody knows for sure what will happen with inflation, I've seen some stuff suggesting it could be down to say 4-5% in a years time or so.

I should pick a low coupon linker with a similar duration and add if to this thread and see what I can come up with. 

I do have the trade Web login, that's where I downloaded the info from for the above, seems platforms like iweb and ii don't have lists of gilts, or if they do they are hidden somewhere! 

ChilliBob

				This might be a bit tricky to read, and the formatting of the post seems a bit odd..!
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ChilliBob

Well, well done to anyone who read the above, sorry about that!

Seems the only linker with a fairly short duration. So it's a tick for a low coupon, but the rest baffles me.

Dirty price of 147, and a yield of 0.051. 

I'm not really sure how to interpret that, in the face of it, it looks like a loss, assuming par value of 100... Which can't be right! 

GeoffTF

Break even inflation here:

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

Real redemption yields in index linked gilts were about -3% before "the house caught fire". They are now about 0%, which is a much, much better deal. Expected inflation has gone up, but gilt yields have gone up even more. The markets expect the central banks to bring inflation under control, but they could be wrong.

I buy gilts using iWeb.

masonic

ChilliBob said:

Well, well done to anyone who read the above, sorry about that!

Seems the only linker with a fairly short duration. So it's a tick for a low coupon, but the rest baffles me.

Dirty price of 147, and a yield of 0.051. 

I'm not really sure how to interpret that, in the face of it, it looks like a loss, assuming par value of 100... Which can't be right!

Index linked gilts don't redeem at £100. They redeem at £100 + RPI since their issue date. The clean price shows you their price with accrued inflation (and accrued interest) stripped out, so this can be compared to a par of £100. In this case £100.09 is extremely close to par, so this is why the YTM is 0.05% + RPI. So it is easier to work with the clean price and just bear in mind there will be quite a difference in the price you are quoted because of inflation to date.

I/L gilts should really be treated as a hedge against higher then forecast inflation. If inflation behaves as predicted, then the return should normally be a little under what you could get from a nominal gilt of similar duration. This could be considered a low price to pay for the valuable protection they offer from time to time when inflation bites. It's worth also noting that the mentioned inflation figure of 4-5% is probably measured using the consistently lower CPI figure. RPI could be 0.5-1% higher. It seems conventional gilts aren't offering returns as high as that, suggesting the market is predicting an even lower inflation figure - but is it right??

ChilliBob

Very interesting stuff, thanks both. So, with conventional gilts, held to maturity, one can be certain what coupon they will receive and the capital gain (or loss!) they have ahead when it matures.

With inflation linked gilts I guess you'd basically plug in a few different inflation rates to try and get the same certainty over those different rates, or, have I over simplified and missed the point, again. 

I can't help but think these aren't as complex as I'm making out in my head, I seem to have some odd mental block around the detail, grr! 

coyrls

The certainty is that what is returned at maturity will be £100 + RPI.  What is uncertain is what RPI will be over the term of the bond. With a conventional bond the return at maturity is certain but what is uncertain is if that return will beat RPI over the term of the bond.

coyrls

I guess another way of saying it, is that with an index linked bond, you know the real return but not the nominal return and with a conventional bond you know the nominal return but not the real return.  In your example, as I understand it, the real return will be 0.051% above RPI.