UK Gilts within SIPP

username12345678

Hi, I’ve read some of the excellent advice on other threads about UK government bonds but have a couple of questions if anyone can give some guidance.

For years I’ve ignored direct holdings in gilt funds because of the ‘return free risk’ profile that ultra-low interest rates created in the space. Now the picture has changed in terms of yield I would like to take a look at whether a gradual increase in exposure might be something that could work for me.

My knowledge and understanding of fixed income isn’t quite what I’d like it to be, and whilst I’m comfortable not knowing chapter & verse, I would like to have a handle on the basic potential risks.

Am I right in thinking that ‘Yield to maturity’ and ‘Duration’ are two of the key concepts?

Taking IGLT as an example:

YTM: 4.6%

Does this mean that on the purchase date the bond fund as a whole will return 4.6%pa…however as the bonds are redeemed and new ones added the YTM will fluctuate. Price changes of the fund however will not affect the yield of the purchase?


Average Duration: 9.6 years

The fund guide says this is a reference point for how much interest rate changes will affect the price of the fund.

In this instance a 1% rise in interest rates would equal a 9.6% fall in bond fund price? And vice versa?


Would it be reasonable to say the main risk is a further increase in yields producing a capital loss? Along with yields lagging inflation, although this is less of a concern for me.

Thanks.

coastline

Not a pretty sight regarding the purchase price of IGLT since launch in 2006.

iShares Core UK Gilts UCITS ETF, UK:IGLT Advanced Chart - (LON) UK:IGLT, iShares Core UK Gilts UCITS ETF Stock Price - BigCharts.com (marketwatch.com)

No different with VGOV another distributing ETF.

Vanguard UK Gilt UCITS ETF, UK:VGOV Advanced Chart - (LON) UK:VGOV, Vanguard UK Gilt UCITS ETF Stock Price - BigCharts.com (marketwatch.com)

You can get an idea of fluctuation from the UK 10 year gilt bond yield . FEB 2023 yield was 3% and today 4.7% . In that time IGLT has moved from 1100 to 980.

UK 10 Year Gilt Bond Yield - 2023 Data - 1980-2022 Historical - 2024 Forecast - Quote (tradingeconomics.com)

iShares Core UK Gilts UCITS ETF, UK:IGLT Advanced Chart - (LON) UK:IGLT, iShares Core UK Gilts UCITS ETF Stock Price - BigCharts.com (marketwatch.com)

You can get some information on yield from these links.

iShares Core UK Gilts UCITS ETF GBP (Dist) (IGLT) Dividend History (dividenddata.co.uk)

iShares Core UK Gilts UCITS ETF GBP (Dist) (IGLT) Dividend Yield - 1.94% (dividenddata.co.uk)

As much as I understand the YTM figure is all things remaining the same until maturity but in reality there's constant changes as you've described above. Not advice but perhaps look at VGOV on the links above.

  VGOV Dividends - Vanguard ETFs (dividenddata.co.uk)

username12345678

Thanks coastline, I appreciate the links and I'll work my way through them.

IGLT and VGOV look ugly on the charts...which is what has raised my interest.

Ciprico

Most of the positive posts on bonds are for individual gilts. (Not a gilt funds).

Individual gilts with short duration have a known purchase  cost, will mature for £100 and have a finite fixed coupon (dividend). Ie no risk.

This assumes you hold to maturation. 

Google tr25 for an example.

The price can vary until it matures but at 7/3/25 it will deliver £100 and will produce about 5% per year until then.

Funds don't mature so don't provide the same certainty.

Buying gilts is not investing, it's saving, providing you hold to maturity....

tichtich

I would push back a bit against the idea that bonds held to maturity have no risk. They have inflation risk. You will get your principal back in full in nominal terms. But you don't know what you will be getting back in real (inflation adjusted) terms. If general prices double over the time to maturity, the principal you get back will be worth only half what it is now. If you're worried about future inflation (as I am) you might be better off buying index-linked bonds.

cwep2

username12345678 said:

Average Duration: 9.6 years

The fund guide says this is a reference point for how much interest rate changes will affect the price of the fund.

In this instance a 1% rise in interest rates would equal a 9.6% fall in bond fund price? And vice versa?


Would it be reasonable to say the main risk is a further increase in yields producing a capital loss? Along with yields lagging inflation, although this is less of a concern for me.

Duration (in a nutshell) is a measure of how much the price will be affected by changes in bond yields. Longer duration, bigger swings in price. 

A 1% rise in BoE interest rates wouldn’t necessarily affect bond prices at all - if it is expected. Essentially the yield curve shows us (approximately) the expected path of interest rates. Right now yields go down from 1yr to 5yr then start going up again beyond that. That’s because most economists think the BoE has reached peak rates (or maybe 1 more hike in next few months) at then in 2024 will start cutting rates which will head on a path down to around 3%. 

Usually there is something called the term premium, where in long dated bonds where we really don’t know much about expected rates between say 20 and 30yrs from now, rates/yields tend to increase. This reflects the fact that interest rate uncertainty and also “credit risk” of essentially lending money to the UK government is greater for 30yrs than for 20. This is the main reason for the upward slope starting at 5yrs. 

There are then weird regulatory or tax reasons or simply supply and demand for certain bonds or regions of the curve that mean that if you tried to draw a line between yields it would be jagged not straight/smooth. 

But it’s changes in bond yields that affect prices (not BoE rates) and the 10yr yield is less about what the BoE is doing now and more about trends in inflation/growth and to some extent supply/demand in the bond market itself - eg govt running larger deficits mean more money needs to be borrowed, which means more bonds need to be sold, which would push down the price and push up yields (see Oct 2022). 

The price change isn’t exactly %move x duration, but that’s a good rule of thumb and won’t be a million miles off. A 10yr bond with coupons in line with current yields would move down approx 8% in price with a 1% move higher in yields. 

Ciprico

tichtich said:

I would push back a bit against the idea that bonds held to maturity have no risk. They have inflation risk. You will get your principal back in full in nominal terms. But you don't know what you will be getting back in real (inflation adjusted) terms. If general prices double over the time to maturity, the principal you get back will be worth only half what it is now. If you're worried about future inflation (as I am) you might be better off buying index-linked bonds.

They will deliver exactly what they claim to deliver.

So no risk.

They don't claim to beat inflation or any other index.

Altior

In layman's terms it's perhaps easier to think of gilts as the inverse of mortgage rates.

Anyone who fixed at 1% is laughing, and the longer fix the better. Anyone needing to fix now however is pretty gutted.

Gilts are the opposite. Anyone who secured a long gilt at 1% is crying compared to anyone who has capital to put into a gilt today. They could trade that 1% gilt on the market, but they are competing with new gilts issued at a multiple rate of interest. So in order to sell it they have to lower the price to less than what it was purchased for, to compensate for the lower rate than the market rate. If they hold that gilt to maturity, nothing changes, the only thing that has changed is the perceived trading value of that gilt on the market whilst they are holding it.

Funds are just an extrapolation of this, the longer the fund duration, the more crying there is going on. But there is a tipping point, as all gilt funds will be buying new gilts at today's issue rates when gilts they hold mature. If you look at the holding of some gilt funds, they will most likely have already purchased gilts at the elevated rates. Now imagine that interest rates fall, and medium/long funds that have been severely beaten down hold quite a lot of gilts at the juicier rates...

Personally I feel like these are a very appealing play, the risk is that rates are unexpectedly hiked again, however there's no point in trying to perfect the timing, in a few years I feel like this may look like a sparkling opportunity. 

masonic

tichtich said:

I would push back a bit against the idea that bonds held to maturity have no risk. They have inflation risk. You will get your principal back in full in nominal terms. But you don't know what you will be getting back in real (inflation adjusted) terms. If general prices double over the time to maturity, the principal you get back will be worth only half what it is now. If you're worried about future inflation (as I am) you might be better off buying index-linked bonds.

"Risk free" is normally defined as a known nominal return as mentioned above, but nominal bonds are only risk free to the extent that cash savings are risk free. While it is helpful for people to consider inflation risk, it is worth pointing out that leaving in cash in their investment account is normally of even greater risk in this context.

JohnWinder

Q1: Yes, key concepts.

Q2: Yes, as long as you reinvest the coupons. Yes, it must fluctuate as new bonds with different yields are added. 

Q3: Yes, but if the price drops and the coupon payments continue as they were (until new bonds replace them), then a price drop and same coupons means the fund will have a higher yield and thus grow in price faster than it was growing before the price fall. Then, newer replacement bonds will have higher yields, further enhancing returns. Bond holders like higher yielding bonds.

Q4: Yes, as a rule of thumb. But, as above, it’s the interest rates of those bonds, not the central bank overnight interest rate that is relevant. They’re linked, but not directly.

Q5; Yes. If you want to ignore inflation, bonds have two risks: default; and duration or interest rate risk (the longer the bond the higher the risk).