Index Linked Gilts (Dirty prices)

jake_jones99

TheGreenFrog said:

Personally, on a short maturity gilt, and especially an ultrashort like 24, I would prefer the conventional over the IL. Even if I like the proposition that inflation will be higher than the rate implicit in the pricing difference between the IL and the conventional, the dealing spread on the IL (although it seems to vary wildy) can be a lot more than on the conventional. This can make a big difference to yield given the ultrashort maturity so I have to have more conviction in the inflation proposition.

I hold both TR24 and TN24 but mostly the latter.  Am currently doing better on the conventional due to high spread when I bought the IL.

Can you please elaborate on the high spread when buying the IL? Could you not set a max value at which you want to buy?

jake_jones99

TheGreenFrog said:

Personally, on a short maturity gilt, and especially an ultrashort like 24, I would prefer the conventional over the IL. Even if I like the proposition that inflation will be higher than the rate implicit in the pricing difference between the IL and the conventional, the dealing spread on the IL (although it seems to vary wildy) can be a lot more than on the conventional. This can make a big difference to yield given the ultrashort maturity so I have to have more conviction in the inflation proposition.

I hold both TR24 and TN24 but mostly the latter.  Am currently doing better on the conventional due to high spread when I bought the IL.

Had a look at TN24, and at the current price the return (extended annually) would be roughly 3.84%. This matches precisely a one-year fix, after you deducted 20% tax. I assume TR24 performed badly as it was trading 10% above par roughly a year ago. But it should compensate towards maturity.

jake_jones99

TheGreenFrog said:

jake_jones99 said:

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.

I have also questioned in my own mind how fast rpi can fall and how the breakeven inflation rate in those 24 gilts can be so low.  But I know nothing about inflation so have assumed the market does and has priced accordingly.  For example I have no idea what the wild swings in oil and gas prices will do to rpi in the next few months and whether the historic data you have looked at has such wild swings.

With regards to the oil and gas swing, one can actually check. You can see how the individual petrol and oil components of the RPI change here: https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/dogq/mm23
One can see they have plunged from 46% to -6% since July last year. However, in the same period RPI all times increased by 1.2%. You can also see the RPI weights at https://www.ons.gov.uk/economy/inflationandpriceindices/datasets/consumerpriceinflationupdatingweightsannexatablesw1tow3 which tells you that petrol and oil represents around 5% of RPI, explaining why it hasn't affected it so much. It may be possible that the drop in oil price might have some long term effects on RPI, which I am unable to predict. But we can see that the change in crude oil over the last century (chart) has seen a lot wilder times than in the last years. Again, I may be totally wrong and things could be different this time. But that's why I still have most of my savings generating interest via conventional instruments.

TheGreenFrog

jake_jones99 said:

Can you please elaborate on the high spread when buying the IL? Could you not set a max value at which you want to buy?

I was referring to the spread in the context of comparing the linker with the equivalent conventional (i.e. TR24 v TN24).  The spread on the conventional is small but the spread on the linker can be quite large but it varies - perhaps because liquidity is a lot lower.  The first time I bought TR24 there were a total of 5 trades reported on LSE on the day, including mine.  It was in excess of 50 basis points above the other trades for the day (all of which were similar prices, give or take 10 basis points), which I assume were all purchases by market makers.  Yet on other days I have been able to buy at a level much closer to the mid price (assumed by looking at the reported trades on LSE).  So the higher spread is a cost disadvantage which the linker has against the conventional and is of particular relevance to an ultrashort of course, but it's not easy to tell what that cost is as you can't just do an online electronic quote for a linker.

jake_jones99 said:

Had a look at TN24, and at the current price the return (extended annually) would be roughly 3.84%. This matches precisely a one-year fix, after you deducted 20% tax. I assume TR24 performed badly as it was trading 10% above par roughly a year ago. But it should compensate towards maturity.

I make it over 4%.  And of course it is liquid which a one year fix is not.  I think the relative performance is really down to timings and the bad buy price of the linker when I bought it (v the conventional on the same day).  Over this year so far TR24 is outperforming TN24 if you just look at the mid dirty price presumably because RPI has been stubbornly high.

jake_jones99

TheGreenFrog said:

jake_jones99 said:

Can you please elaborate on the high spread when buying the IL? Could you not set a max value at which you want to buy?

I was referring to the spread in the context of comparing the linker with the equivalent conventional (i.e. TR24 v TN24).  The spread on the conventional is small but the spread on the linker can be quite large but it varies - perhaps because liquidity is a lot lower.  The first time I bought TR24 there were a total of 5 trades reported on LSE on the day, including mine.  It was in excess of 50 basis points above the other trades for the day (all of which were similar prices, give or take 10 basis points), which I assume were all purchases by market makers.  Yet on other days I have been able to buy at a level much closer to the mid price (assumed by looking at the reported trades on LSE).  So the higher spread is a cost disadvantage which the linker has against the conventional and is of particular relevance to an ultrashort of course, but it's not easy to tell what that cost is as you can't just do an online electronic quote for a linker.

jake_jones99 said:

Had a look at TN24, and at the current price the return (extended annually) would be roughly 3.84%. This matches precisely a one-year fix, after you deducted 20% tax. I assume TR24 performed badly as it was trading 10% above par roughly a year ago. But it should compensate towards maturity.

I make it over 4%.  And of course it is liquid which a one year fix is not.  I think the relative performance is really down to timings and the bad buy price of the linker when I bought it (v the conventional on the same day).  Over this year so far TR24 is outperforming TN24 if you just look at the mid dirty price presumably because RPI has been stubbornly high.

I traded today and it was an interesting experience. I feel the negotiation played a part too. I first asked the dealer for some guidance and he said the advised value for buying was 100.93 and selling 98.43. Being a very disagreeable person I asked for a fill-or-kill order with a max of 99.5 just to probe the market. I knew it would be rejected, but what surprised me was they came back with a suggestion of 99.66, which I accepted and then the trade went through. The initial advice was more than 1% higher, they are clearly out there to leave you out of pocket if they can, and seems negotiations are a must. So I get the problem with liquidity. 

I checked the trades on LSE and there aren't many, as you said, but mine isn't even there. Possibly my bonds came from a bigger pot ordered at the same time? Or maybe I dealt too close to the closing time. However, compared to the one displayed, only 3 out of 17 trades were done at a cheaper price. May be beginner's luck. 

coyrls

jake_jones99 said:

TheGreenFrog said:

jake_jones99 said:

Can you please elaborate on the high spread when buying the IL? Could you not set a max value at which you want to buy?

I was referring to the spread in the context of comparing the linker with the equivalent conventional (i.e. TR24 v TN24).  The spread on the conventional is small but the spread on the linker can be quite large but it varies - perhaps because liquidity is a lot lower.  The first time I bought TR24 there were a total of 5 trades reported on LSE on the day, including mine.  It was in excess of 50 basis points above the other trades for the day (all of which were similar prices, give or take 10 basis points), which I assume were all purchases by market makers.  Yet on other days I have been able to buy at a level much closer to the mid price (assumed by looking at the reported trades on LSE).  So the higher spread is a cost disadvantage which the linker has against the conventional and is of particular relevance to an ultrashort of course, but it's not easy to tell what that cost is as you can't just do an online electronic quote for a linker.

jake_jones99 said:

Had a look at TN24, and at the current price the return (extended annually) would be roughly 3.84%. This matches precisely a one-year fix, after you deducted 20% tax. I assume TR24 performed badly as it was trading 10% above par roughly a year ago. But it should compensate towards maturity.

I make it over 4%.  And of course it is liquid which a one year fix is not.  I think the relative performance is really down to timings and the bad buy price of the linker when I bought it (v the conventional on the same day).  Over this year so far TR24 is outperforming TN24 if you just look at the mid dirty price presumably because RPI has been stubbornly high.

I traded today and it was an interesting experience. I feel the negotiation played a part too. I first asked the dealer for some guidance and he said the advised value for buying was 100.93 and selling 98.43. Being a very disagreeable person I asked for a fill-or-kill order with a max of 99.5 just to probe the market. I knew it would be rejected, but what surprised me was they came back with a suggestion of 99.66, which I accepted and then the trade went through. The initial advice was more than 1% higher, they are clearly out there to leave you out of pocket if they can, and seems negotiations are a must. So I get the problem with liquidity. 

I checked the trades on LSE and there aren't many, as you said, but mine isn't even there. Possibly my bonds came from a bigger pot ordered at the same time? Or maybe I dealt too close to the closing time. However, compared to the one displayed, only 3 out of 17 trades were done at a cheaper price. May be beginner's luck. 

That matches my experience with no negotiation.  They quote a much wider spread than the actual quote you get, which is near the midpoint.

adamdylan

Hi guys Mindblowing read.!. (Pensioncraft on youtube estimates a return "Why I bought inflation link bonds " 10 min in ) Where can ? and where is best to buy ? and is haggling needed ? Plus any other practical advice? Thanks !

jake_jones99

adamdylan said:

Hi guys Mindblowing read.!. (Pensioncraft on youtube estimates a return "Why I bought inflation link bonds " 10 min in ) Where can ? and where is best to buy ? and is haggling needed ? Plus any other practical advice? Thanks !

I think if you read through this thread you'll see lots of advice. That YouTube video actually tells you a lot of details.

adamdylan

Dh6 said:

Every time I think I’m beginning to finally understand bonds, threads like this pop up to confirm I still know nothing! 🙈

 Re read and on 2nd blush could see no broker comparison Maybe we should stick to shares  Dh6 😀

jake_jones99

adamdylan said:

Dh6 said:

Every time I think I’m beginning to finally understand bonds, threads like this pop up to confirm I still know nothing! 🙈

 Re read and on 2nd blush could see no broker comparison Maybe we should stick to shares  Dh6 😀

Pensioncraft used interactive investors. I used Aj Bell dealing account because it turned out cheaper in my case. Research a couple of them and see what's best for you. Not all brokers do gilts though