Filling the gap to state/db pension using an index linked bond ladder in SIPP - how?

zagfles

michaels said:

najan49 said:

This is my current understanding which could be way out!

£97.85 is the clean price, you will actually pay the dirty price which is about £151.30.

The redemption price would be 100 * RPI at (22 Dec 2023) / reference index (242.42ish)

if the RPI stayed the same between now and December (it won’t) the input value for RPI would be 376.4 and so the redemption price would be about £155.26. Plus a tiny coupon.


Actual reference index is on the prospectus here: https://www.dmo.gov.uk/media/dlvn3pc5/pr021012b.pdf
RPI is here https://www.ons.gov.uk/economy/inflationandpriceindices

So do we know what the clean price represents?  Is it some sort of rebasing?  What tells us that the current real yield is +0.5% or whatever as per Old Scientists posts?

Plus again how do we model the coupons?  Seems to me there is probably a spreadsheet out there already with all this stuff in it.

You can download a spreadsheet here although annoying it doesn't include the base RPI which would be very useful, but does have the index ratio. https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D1D

Coupons are uplifted with inflation on the same basis as redemption ie either a 3 month or 8 month index lag. Have a read of https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

Linton

michaels said:

najan49 said:

This is my current understanding which could be way out!

£97.85 is the clean price, you will actually pay the dirty price which is about £151.30.

The redemption price would be 100 * RPI at (22 Dec 2023) / reference index (242.42ish)

if the RPI stayed the same between now and December (it won’t) the input value for RPI would be 376.4 and so the redemption price would be about £155.26. Plus a tiny coupon.


Actual reference index is on the prospectus here: https://www.dmo.gov.uk/media/dlvn3pc5/pr021012b.pdf
RPI is here https://www.ons.gov.uk/economy/inflationandpriceindices

So do we know what the clean price represents?  Is it some sort of rebasing?  What tells us that the current real yield is +0.5% or whatever as per Old Scientists posts?

Plus again how do we model the coupons?  Seems to me there is probably a spreadsheet out there already with all this stuff in it.

The dirty price is what you pay which can be much higher than £100 because you are paying for the RPI increase in value up to when you purchase.  The dirty price also includes an adjustment for the fact that interest is paid every 6 months on fixed dates.  Therefore the first interest payment you receive is likely to cover a time when you did not actually own the bond. This prevents a step change in gilt prices when interest is paid.

The clean price of an IL fund is what is published in most tables and is the dirty price after the removal of the accrued inflation and the first interest factor..  This enables meaningful comparisons to be made between IL gilts which started at different dates and also enables comparisons to be made between IL gilts and fixed gilts.

Clean and dirty pricing also applies to fixed bonds because of the first interest payment effect though of course the difference between the two is much smaller than for IL bonds.

IL yields are extremely complicated, I think I understand them vaguely.  My understanding which could well be confused or wrong is that the published yields are  relative to an assumed final overall value of inflation and represent the average annual compounded interest that would achieve the same overall total return. The assumed annual inflation value is 3% for old bonds and(I think) the annualised value to date for new bonds.  The calculation is different I believe when near to maturity. A negative yield would represent a total return of less than the assumed value of inflation given the current price.

Hopefully someone can provide a better explanation.

Some light reading: https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

JohnWinder

To be precise it’s a non-rolling ladder you’re after (the harder type). Here's a good account https://retirementresearcher.com/how-do-i-build-a-tips-bond-ladder-for-retirement-income/ ,  but basically you start at the last year of your ladder, decide how many maturing bonds you need for the last year’s income, then calculate how much these bonds will provide towards all the earlier years income, with their coupons. This allows you to decide how many bonds you need to buy for the penultimate year….and on it goes. You never have to sell a bond. Once you set it up, you forget it. See also:

https://www.bogleheads.org/forum/viewtopic.php?t=128677
You don’t need to know what the current yields on the bonds are because what you enter into your spreadsheet is the coupon (and the inflation adjusted value), not that current yields aren’t easy to find.

‘here are a few years without, such as 2025 & 2030. For those years I assume you buy double the amount of the 2026 or 2031 and sell the relevant amount as appropriate?’

Yes. An alternative, using 2030 when none mature, is to buy more of the 2029’s such that they fill the 2030 gap. Why? Because if you can avoid selling into the market (by simply taking redemptions) you can’t get the bad side of the trade or pay any trading costs; and, the ladder becomes totally ‘hands off’ - you set it up and never have to deal with it again. You get a lumpy ladder, as you would with selling, and you have imperfect inflation protection (lasts only a year or so) but it’s set and forget.

Get back to us if you're struggling.

OldScientist

For IL gilts, to calculate the real (i.e. inflation adjusted) yield, you need the clean price (which is what is quoted at the LSE), the coupon yield, and the coupon frequency (twice per year - I think this is true for all UK gilts?)

You can then use the yield function (available in excel, libreoffice, etc.) to calculate the real yield (be careful to look at the help - getting the units right is essential).

There are no assumptions of what inflation will be in this calculation (but more on that below).

The real yield will then tell you what your investment will be worth at maturity (this assumes reinvestment of coupons, which for small amounts is probably not worthwhile after taking into account transaction fees).

So, if you invest £10k at 0.5% ytm for 10 years, when the bond matures it will be worth 10000*(1.005)^10=£10511 in today's money. If inflation averages 3% over the next 10 years, then in nominal pounds your investment will be worth £10511*(1.03)^10=£14126.

This is the key difference between nominal and IL bonds. With nominal bonds you know exactly how many nominal pounds they will be worth at maturity but have no idea what they will be worth in real terms, while for IL bonds, you know exactly that they will be worth in real terms, but no idea what they will be worth in nominal terms. Implied inflation (see https://www.bankofengland.co.uk/statistics/yield-curves ) then tells you what the market is pricing in as the 'expected' inflation. If inflation turns out to be higher, then IL bonds will perform best and vice versa.

OldScientist

Here's an example using the libreoffice yield function (TR31)



This is using the closing price on 21 July 2023 (from tradeweb - it requires a login, but registration is free, the DMO outsourced this to tradeweb a while back) of the ILG maturing in 2031. The tradeweb yield was 0.438% (to 3 decimal places) - I think I haven't quite got the settlement date over a weekend right in my calculation, but it is close enough. Remember these are real yields for this particular gilt.

The advantage of implementing this yourself is that you can put the current offer price for TR31 (see https://www.londonstockexchange.com/live-markets/market-data-dashboard/price-explorer?categories=BONDS&subcategories=14 ) of 98.05 (as at 09:08 today) into the spreadsheet to get an updated yield (approx 0.37%).

OldScientist

michaels said:

najan49 said:

This is my current understanding which could be way out!

£97.85 is the clean price, you will actually pay the dirty price which is about £151.30.

The redemption price would be 100 * RPI at (22 Dec 2023) / reference index (242.42ish)

if the RPI stayed the same between now and December (it won’t) the input value for RPI would be 376.4 and so the redemption price would be about £155.26. Plus a tiny coupon.


Actual reference index is on the prospectus here: https://www.dmo.gov.uk/media/dlvn3pc5/pr021012b.pdf
RPI is here https://www.ons.gov.uk/economy/inflationandpriceindices

So do we know what the clean price represents?  Is it some sort of rebasing?  What tells us that the current real yield is +0.5% or whatever as per Old Scientists posts?

Plus again how do we model the coupons?  Seems to me there is probably a spreadsheet out there already with all this stuff in it.

For index linked gilts the clean price represents the current price with respect to the redemption price in real terms. So, an ILG with a redemption price of 100 and a current price of 98 will have approximately 2% of capital growth to maturity plus (the generally relatively small) coupons.

One of the reasons that the real prices are used (including the quotes on the LSE) is that no assumptions have to be made about future inflation. Of course, the ILG are paid for in nominal pounds, so the inflationary growth to date is included in the actual price paid and, on redemption (neglecting spreads), the price received (as najan49 said).

On iweb (where I hold my ILG), the price paid is the nominal one, but the current price listed is the real one, so on a cursory glance all the bonds appear to have a huge loss - annoyingly, this means that I have to manually calculate the nominal prices (I only do this every  6 months when I am about to withdraw money and since I'm holding to maturity it doesn't really matter). To be fair to iweb, each time you purchase ILG, they do tell you of this idiosyncrasy in their reporting (I assume it is because they scrape the current price off of the LSE).

Linton

OldScientist said:

Here's an example using the libreoffice yield function (TR31)



This is using the closing price on 21 July 2023 (from tradeweb - it requires a login, but registration is free, the DMO outsourced this to tradeweb a while back) of the ILG maturing in 2031. The tradeweb yield was 0.438% (to 3 decimal places) - I think I haven't quite got the settlement date over a weekend right in my calculation, but it is close enough. Remember these are real yields for this particular gilt.

The advantage of implementing this yourself is that you can put the current offer price for TR31 (see https://www.londonstockexchange.com/live-markets/market-data-dashboard/price-explorer?categories=BONDS&subcategories=14 ) of 98.05 (as at 09:08 today) into the spreadsheet to get an updated yield (approx 0.37%).

Interesting - the link I gave (https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/) is about the formulae used to calculate the dirty price from the yield or vice versa.  The method is different for old 8-month index lag bonds and the modern 3-month indexation lag ones and is also different before and after the final index value is known..  All calculations look very complicated.

I had not realised that it is a simple calculation from the clean price, at least to a sufficient degree of accuracy.

zagfles

JohnWinder said:

To be precise it’s a non-rolling ladder you’re after (the harder type). Here's a good account https://retirementresearcher.com/how-do-i-build-a-tips-bond-ladder-for-retirement-income/ ,  but basically you start at the last year of your ladder, decide how many maturing bonds you need for the last year’s income, then calculate how much these bonds will provide towards all the earlier years income, with their coupons. This allows you to decide how many bonds you need to buy for the penultimate year….and on it goes. You never have to sell a bond. Once you set it up, you forget it. See also:

https://www.bogleheads.org/forum/viewtopic.php?t=128677
You don’t need to know what the current yields on the bonds are because what you enter into your spreadsheet is the coupon (and the inflation adjusted value), not that current yields aren’t easy to find.

‘here are a few years without, such as 2025 & 2030. For those years I assume you buy double the amount of the 2026 or 2031 and sell the relevant amount as appropriate?’

Yes. An alternative, using 2030 when none mature, is to buy more of the 2029’s such that they fill the 2030 gap. Why? Because if you can avoid selling into the market (by simply taking redemptions) you can’t get the bad side of the trade or pay any trading costs; and, the ladder becomes totally ‘hands off’ - you set it up and never have to deal with it again. You get a lumpy ladder, as you would with selling, and you have imperfect inflation protection (lasts only a year or so) but it’s set and forget.

Get back to us if you're struggling.

Yes, this is what I did. Don't get hung up to complicated "yield" % calculations, you don't need them. You know what the yield amount will be in real terms for each gilt, so work backwards from the last year and deduct the yield amount from the required maturing amount to work out how much you need to buy. Don't forget to account for charges

But there is a gilt maturing in 2030, T30I, an old style 8-month lag gilt where the price is quoted dirty (includes the inflation uplift, but not the accrued interest).

michaels

zagfles said:

JohnWinder said:

To be precise it’s a non-rolling ladder you’re after (the harder type). Here's a good account https://retirementresearcher.com/how-do-i-build-a-tips-bond-ladder-for-retirement-income/ ,  but basically you start at the last year of your ladder, decide how many maturing bonds you need for the last year’s income, then calculate how much these bonds will provide towards all the earlier years income, with their coupons. This allows you to decide how many bonds you need to buy for the penultimate year….and on it goes. You never have to sell a bond. Once you set it up, you forget it. See also:

https://www.bogleheads.org/forum/viewtopic.php?t=128677
You don’t need to know what the current yields on the bonds are because what you enter into your spreadsheet is the coupon (and the inflation adjusted value), not that current yields aren’t easy to find.

‘here are a few years without, such as 2025 & 2030. For those years I assume you buy double the amount of the 2026 or 2031 and sell the relevant amount as appropriate?’

Yes. An alternative, using 2030 when none mature, is to buy more of the 2029’s such that they fill the 2030 gap. Why? Because if you can avoid selling into the market (by simply taking redemptions) you can’t get the bad side of the trade or pay any trading costs; and, the ladder becomes totally ‘hands off’ - you set it up and never have to deal with it again. You get a lumpy ladder, as you would with selling, and you have imperfect inflation protection (lasts only a year or so) but it’s set and forget.

Get back to us if you're struggling.

Yes, this is what I did. Don't get hung up to complicated "yield" % calculations, you don't need them. You know what the yield amount will be in real terms for each gilt, so work backwards from the last year and deduct the yield amount from the required maturing amount to work out how much you need to buy. Don't forget to account for charges

But there is a gilt maturing in 2030, T30I, an old style 8-month lag gilt where the price is quoted dirty (includes the inflation uplift, but not the accrued interest).

Perhaps it was too tricky to calculate the clean price for the 8 month lag ones so they just quote the market price....

zagfles

michaels said:

zagfles said:

JohnWinder said:

To be precise it’s a non-rolling ladder you’re after (the harder type). Here's a good account https://retirementresearcher.com/how-do-i-build-a-tips-bond-ladder-for-retirement-income/ ,  but basically you start at the last year of your ladder, decide how many maturing bonds you need for the last year’s income, then calculate how much these bonds will provide towards all the earlier years income, with their coupons. This allows you to decide how many bonds you need to buy for the penultimate year….and on it goes. You never have to sell a bond. Once you set it up, you forget it. See also:

https://www.bogleheads.org/forum/viewtopic.php?t=128677
You don’t need to know what the current yields on the bonds are because what you enter into your spreadsheet is the coupon (and the inflation adjusted value), not that current yields aren’t easy to find.

‘here are a few years without, such as 2025 & 2030. For those years I assume you buy double the amount of the 2026 or 2031 and sell the relevant amount as appropriate?’

Yes. An alternative, using 2030 when none mature, is to buy more of the 2029’s such that they fill the 2030 gap. Why? Because if you can avoid selling into the market (by simply taking redemptions) you can’t get the bad side of the trade or pay any trading costs; and, the ladder becomes totally ‘hands off’ - you set it up and never have to deal with it again. You get a lumpy ladder, as you would with selling, and you have imperfect inflation protection (lasts only a year or so) but it’s set and forget.

Get back to us if you're struggling.

Yes, this is what I did. Don't get hung up to complicated "yield" % calculations, you don't need them. You know what the yield amount will be in real terms for each gilt, so work backwards from the last year and deduct the yield amount from the required maturing amount to work out how much you need to buy. Don't forget to account for charges

But there is a gilt maturing in 2030, T30I, an old style 8-month lag gilt where the price is quoted dirty (includes the inflation uplift, but not the accrued interest).

Perhaps it was too tricky to calculate the clean price for the 8 month lag ones so they just quote the market price....

It would be easier as they don't use intermonth interpolation, however they would be 8 months of date wrt inflation.

Clean prices are useful for a quick guide as to whether the gilts are good value or not, but dirty prices are better once you've bought them so you know the current value. On HL, and most platfoms I think, you see the clean price x number bought so it looks like you've made an immediate massive capital loss after buying the new style gilts!