Linkers...

aroominyork

I haven't seen much discussion on here about index-linked gilts, the asset class which has done the opposite of what many people expected them to do. You would think they would come into their own when inflation rises, but an index-linked index fund is down over 40% since December 2021 (and hit -50% in Kamikwasi days). From what I understand (as a Capital Gearing Trust investor, and thank goodness for the discount control policy) it is because rising base rates have worked as they do with nominal gilts in reducing values and have more than offset the inflation protection. If that is right, and since the main tool to combat inflation is to raise base rates, my question is why has it gone so wrong this time and when do linkers deliver what they say on the tin?

ispookie666

I posted a thread a few days ago

https://forums.moneysavingexpert.com/discussion/6459524/index-linked-gilt-etf/p1

masonic

Linkers deliver exactly what they say on the tin if you hold them to maturity. When you look at a fund, the performance illustrates what you'd get if you bought the at some time in the past and then sold the current underlying assets today.

Linton

A fairly superficial explanation...

The problem is with the underlying index linked gilts.  Before the recent interest rate rises the market's estimate of long term inflation was perhaps something like 2.5-3% and comparable fixed interest rates were perhaps 1%.  Therefore index linked gilts were highly desirable simply because they generated good long term returns compared with other safe bonds.  So they became very expensive with prices well above par

Since the rise in interest rates fixed term gilts are generating over 4% whilst the market's view of long term inflation wont have changed much.  Therefore long term index linked gilts are now undesirable as investments and the price has collapsed to close to par.

If you had bought a single index linked gilt on maturity your investment would be worth exactly what you were promised when you bought the gilt.  But between buying and maturity the price can vary greatly dependent on wider interest rates.

When you buy an index linked gilt fund you will be getting a basket of underlying gilts with maturity dates varying from a few months  time to perhaps 50 years from now.  When you sell you will be selling a basket of gilts with maturity dates spread over the same range of dates.  Most of the underlying gilts will be some way from maturity and so liable to significant price instability.

The key lesson to learn is that gilt funds and particularly inflation linked index trackers behave very differently to single gilts.

aroominyork

CGT holds many short-dated individual linkers and while it hasn't suffered anything like the bloodbath of an index fund crammed with long-dated ones, it has been pretty ugly - certainly alongside its nearest comparator PNL or a hedged global bond fund. Unless CGT shortened its duration too late in the day, why has it suffered as much as it has?

Linton

aroominyork said:

CGT holds many short-dated individual linkers and while it hasn't suffered anything like the bloodbath of an index fund crammed with long-dated ones, it has been pretty ugly - certainly alongside its nearest comparator PNL or a hedged global bond fund. Unless CGT shortened its duration too late in the day, why has it suffered as much as it has?

They are now significantly invested in a range of IL Gilts, a year ago they were more into short dated US IL bonds.
What that means I dont know, perhaps they were expecting UK inflation and interest rates to level off more quickly than they did.  They could be proved right by next year, who knows.

See https://www.capitalgearingtrust.com/reports-and-documents/ for a lot more info on their holdings.  I would be interested in any conclusions you come to.

masonic

aroominyork said:

CGT holds many short-dated individual linkers and while it hasn't suffered anything like the bloodbath of an index fund crammed with long-dated ones, it has been pretty ugly - certainly alongside its nearest comparator PNL or a hedged global bond fund. Unless CGT shortened its duration too late in the day, why has it suffered as much as it has?

You asked this before. About half of its "equities" exposure was invested in REITs, and those have taken a real nose-dive due to recession fears and increased borrowing costs. It did sell out of most of them after sustaining heavy losses. Not all of its bond holdings were short dated, and it increased duration prematurely. For example, a couple of months ago, two of its five largest bond holdings were over 20 years to maturity. There is also the drop from a small premium to a discount to NAV. Most of the losses appear to be down to asset allocation choices and market timing unrelated to the short dated linkers.

aroominyork

Linton said:

)aroominyork said:

CGT holds many short-dated individual linkers and while it hasn't suffered anything like the bloodbath of an index fund crammed with long-dated ones, it has been pretty ugly - certainly alongside its nearest comparator PNL or a hedged global bond fund. Unless CGT shortened its duration too late in the day, why has it suffered as much as it has?

They are now significantly invested in a range of IL Gilts, a year ago they were more into short dated US IL bonds.
What that means I dont know, perhaps they were expecting UK inflation and interest rates to level off more quickly than they did.  They could be proved right by next year, who knows.

I went to CGT's 2022 AGM where Peter Spiller was expecting the Fed to pivot around the end of 2022. That makes it curious they held short dated US Treasuries.

JohnWinder

..as they do with nominal gilts in reducing values and have more than offset the inflation protection. If that is right, a

I think you’re right. 

…and since the main tool to combat inflation is to raise base rates, my question is why has it gone so wrong this time and when do linkers deliver what they say on the tin?

If ‘wrong’ is falling in value more than our cost of living is increasing, then you’re overlooking the influence of bond duration on prices following interest rate changes which you surely know about. Like it or not, bond and bond fund prices are pushed down when interest rates rise, the longer the duration the harder the push. As to ‘the tin’, the BoE tin says: ‘Index-linked gilts differ from conventional gilts in that the semi-annual coupon payments and the principal repayment are adjusted in line with the UK Retail Prices Index (RPI) with a lag. This means that both the coupons and the principal repaid on redemption of these gilts are adjusted to take account of accrued inflation since the gilt was first issued.’

Which tin are you reading from?

Prism

There seems to be a combination of lack of retail demand and lack of choice for index linked funds suitable for retail investors. The pension providers are perfectly happy with long duration bonds and gilts, and the governments are perfectly happy to issue them. This pushes the average duration of the main index of these things into higher risk categories than retail investors probably want.

I reckon there are just a few suitable funds, most of which are pretty small in size.

Royal London and abrdn both follow the same benchmark and are hedged to GBP and 5 year average duration.

RL

Short Duration Global Index Linked PDF Factsheet (morningstar.com)

abrdn

doc.morningstar.com/document/d477f83dbe195b85031fa723101324b3.msdoc/

Then one passive ETF from Amundi (Lyxor)

doc.morningstar.com/document/fa381d21091152a8ebc945d458cb37c6.msdoc/

There are no short duration index linked gilt funds on the market as far as I know.

masonic

Prism said:
There are no short duration index linked gilt funds on the market as far as I know.

Presumably the reason for this is that it is challenging to run an investment fund drawing from a universe of underlying holdings that much of the time you could count on the fingers of one hand.