Index Linked Gilts (Dirty prices)

coyrls

When I bought index linked bonds through Halifax Share Dealing, the dealer quoted the clean price but asked me if I wanted to know the dirty price before he placed the order.  I said I didn't want to know the dirty price, as the process of getting to the dirty price is purely mechanical (all be it complicated) once the clean price has been established.

jake_jones99

easysaver said:

jake_jones99 said:

Linton said:

jake_jones99 said:

https://forums.moneysavingexpert.com/discussion/comment/80029458#Comment_80029458

I already calculated these but I am used to the trader confirming the final price before the purchase. You all do have a point that the clean price should tell you everything, but in the case of IL bonds the reference RPI is actually the one making the big change in principal (the coupon is negligible on the one I'm looking at). So let's assume for the sake of the argument you manage to buy exactly when the price is £100 (par). Then you have to fully rely on your RPI calculations to know how much you get at the end until the money actually comes in. Again, I know the computations aren't that hard (just a few fractions given the coupon is negligible). I guess it's just about getting used to a new instrument. Thanks everyone!

AIUI, the amount you get at the end as a % of your investment in IL bonds is more easily calculated from the clean price than from the dirty price and in both cases will depend on the actual future inflation rates.   The dirty price is all about accounting for the accrued gains made before you buy the bond, which you dont need to know in order to calculate what you will make after you buy it.

What I meant is you need the inflation-adjusted clean price. I was mistakenly calling this the dirty price but that just accounts for the accrued interest. So I agree you just need the inflation-adjusted clean price to work out the redemption, and they would make your life easier if they also displayed this. But you can work it out by yourself 

You're probably aware of the redemption payment report on the DMO but on the off chance you haven't seen it:
https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D9C

I wasn't able to find an IL calculator the last time I searched but you'd of thought there's enough interest for someone to develop one.

Thanks, I haven't seen it before, but I seems it simply takes the current dirty price (or maybe just the inflation adjusted clean price) and adds the percentages you assume. It's good for confirmation though.

jake_jones99

I will lay out my rationale for investing in this gilt, both for my future reference and in case you have any comments.
I downloaded the monthly percentage RPI data (Jan 1987=100) from 1948-present from the ons website. I am computing a worst case scenario, by selecting 20 values when the RPI peaked, and assuming I would buy at that point, trying to compute how steeply the RPI can fall. Assuming the peak is 13.5% (current RPI), I computed the potential falls in percentage RPI in a 12-month period, by assuming a fall proportional to the selected 20 peaks. 

Apart from an outlier during the financial crisis in 2008 when you would have lost ~3.5%, every other case gives you a positive return. The average is 6.12% (remember these are worst case scenarios). However, I find 2008 to not be a relevant example given the RPI was much lower ~5%, but might be wrong here.

In conclusion, it seems that, unless very unlucky, this gilt will likely give you around 6% tax-free in a 12 month period, which beats savings accounts by far. Please let me know if you see any major flaw. Otherwise I will be back in a year to re-assess my own analysis. 

Disclaimer: I am aware this is just a speculation and not a guarantee, but it confirmed my intuition that it's very unlikely that the RPI would get very low in a year. 

Linton

jake_jones99 said:

I will lay out my rationale for investing in this gilt, both for my future reference and in case you have any comments.
I downloaded the monthly percentage RPI data (Jan 1987=100) from 1948-present from the ons website. I am computing a worst case scenario, by selecting 20 values when the RPI peaked, and assuming I would buy at that point, trying to compute how steeply the RPI can fall. Assuming the peak is 13.5% (current RPI), I computed the potential falls in percentage RPI in a 12-month period, by assuming a fall proportional to the selected 20 peaks. 

Apart from an outlier during the financial crisis in 2008 when you would have lost ~3.5%, every other case gives you a positive return. The average is 6.12% (remember these are worst case scenarios). However, I find 2008 to not be a relevant example given the RPI was much lower ~5%, but might be wrong here.

In conclusion, it seems that, unless very unlucky, this gilt will likely give you around 6% tax-free in a 12 month period, which beats savings accounts by far. Please let me know if you see any major flaw. Otherwise I will be back in a year to re-assess my own analysis. 

Disclaimer: I am aware this is just a speculation and not a guarantee, but it confirmed my intuition that it's very unlikely that the RPI would get very low in a year. 

I do not understand what you are trying to do.  It seems counter-intuit9ive to buy an IL Gilt when RPI is high.  One aspect certainly is not clear - at what price are you assuming you can buy your IL Gilts?  Until the recent rise in iterest rates as IL Gilts were priced well above par they would not even provide inflation matching.

Also IL Gilts were first introduced in 1996 so I( do not see how you can backtest to 1947.

coyrls

How would you profit by buying when inflation is high and selling when inflation is dropping?  When inflation expectations are low, particularly when interest rates are high, it is likely that index linked bond prices will drop and you could be selling at a loss.

jake_jones99

coyrls said:

How would you profit by buying when inflation is high and selling when inflation is dropping?  When inflation expectations are low, particularly when interest rates are high, it is likely that index linked bond prices will drop and you could be selling at a loss.

The assumption is you keep it until redemption. So then I don't care about interest rates, and all I care about is the RPI. Obviously if RPI stays the same or increases then you would turn a profit. So I consider what happens when it falls abruptly, as worst case scenario. As the data shows, the RPI (generally) doesn't just fall by 10% or so in 12 months. In fact, when reaching peak values, it generally drops by roughly 5-6% in 12 months. The idea is, even if it's falling, it has some momentum and would tend not to go to drop too fast. If you look at the first plot, you see the rate of drop from the peak tends to be roughly the same (i.e. ~5-6% per year). Again, no guarantee, just analysis based on past performance.

zagfles

coyrls said:

How would you profit by buying when inflation is high and selling when inflation is dropping?  When inflation expectations are low, particularly when interest rates are high, it is likely that index linked bond prices will drop and you could be selling at a loss.

The gilt the OP is talking about matures next March, so presumably he/she will hold it till then, the clean price is around £100, so theroetically there should be no real capital gain or loss on it, but a nominal gain on whatever RPI is between now and then (or between 3 months ago and Dec as there's a 3 month lag). If I've understood correctly.

jake_jones99

Linton said:

jake_jones99 said:

I will lay out my rationale for investing in this gilt, both for my future reference and in case you have any comments.
I downloaded the monthly percentage RPI data (Jan 1987=100) from 1948-present from the ons website. I am computing a worst case scenario, by selecting 20 values when the RPI peaked, and assuming I would buy at that point, trying to compute how steeply the RPI can fall. Assuming the peak is 13.5% (current RPI), I computed the potential falls in percentage RPI in a 12-month period, by assuming a fall proportional to the selected 20 peaks. 

Apart from an outlier during the financial crisis in 2008 when you would have lost ~3.5%, every other case gives you a positive return. The average is 6.12% (remember these are worst case scenarios). However, I find 2008 to not be a relevant example given the RPI was much lower ~5%, but might be wrong here.

In conclusion, it seems that, unless very unlucky, this gilt will likely give you around 6% tax-free in a 12 month period, which beats savings accounts by far. Please let me know if you see any major flaw. Otherwise I will be back in a year to re-assess my own analysis. 

Disclaimer: I am aware this is just a speculation and not a guarantee, but it confirmed my intuition that it's very unlikely that the RPI would get very low in a year. 

I do not understand what you are trying to do.  It seems counter-intuit9ive to buy an IL Gilt when RPI is high.  One aspect certainly is not clear - at what price are you assuming you can buy your IL Gilts?  Until the recent rise in iterest rates as IL Gilts were priced well above par they would not even provide inflation matching.

Also IL Gilts were first introduced in 1996 so I( do not see how you can backtest to 1947.

This gilt is currently priced around par. I know it's counter intuitive, but the idea (as seen in the other answer) is that the slope by which it falls tends to be limited.

jake_jones99

zagfles said:

coyrls said:

How would you profit by buying when inflation is high and selling when inflation is dropping?  When inflation expectations are low, particularly when interest rates are high, it is likely that index linked bond prices will drop and you could be selling at a loss.

The gilt the OP is talking about matures next March, so presumably he/she will hold it till then, the clean price is around £100, so theroetically there should be no real capital gain or loss on it, but a nominal gain on whatever RPI is between now and then (or between 3 months ago and Dec as there's a 3 month lag). If I've understood correctly.

That's correct.

zagfles

jake_jones99 said:

I will lay out my rationale for investing in this gilt, both for my future reference and in case you have any comments.
I downloaded the monthly percentage RPI data (Jan 1987=100) from 1948-present from the ons website. I am computing a worst case scenario, by selecting 20 values when the RPI peaked, and assuming I would buy at that point, trying to compute how steeply the RPI can fall. Assuming the peak is 13.5% (current RPI), I computed the potential falls in percentage RPI in a 12-month period, by assuming a fall proportional to the selected 20 peaks. 

Apart from an outlier during the financial crisis in 2008 when you would have lost ~3.5%, every other case gives you a positive return. The average is 6.12% (remember these are worst case scenarios). However, I find 2008 to not be a relevant example given the RPI was much lower ~5%, but might be wrong here.

In conclusion, it seems that, unless very unlucky, this gilt will likely give you around 6% tax-free in a 12 month period, which beats savings accounts by far. Please let me know if you see any major flaw. Otherwise I will be back in a year to re-assess my own analysis. 

Disclaimer: I am aware this is just a speculation and not a guarantee, but it confirmed my intuition that it's very unlikely that the RPI would get very low in a year. 

Looks like the buy price is 100.85 so that'll chop almost 1% off, and there'll be dealing costs, maybe platform costs, so need to chop those off the gain too.