UK Gilts - Low Coupon Rates

Linton

newatc said:

The more I read on indexed linked, the more I think I'll keep to the standard gilts and leave the indexed-linked to those with more brain power than me 

They do give you what you want - lower interest in £ terms with a higher capital gain compared with equivalent fixed gilts. Though I agree it is very sensible not to invest in things you do not understand.

OldScientist

newatc said:

The more I read on indexed linked, the more I think I'll keep to the standard gilts and leave the indexed-linked to those with more brain power than me 

IMV, they are just as easy as nominal bonds provided you work in real money rather than nominal. That is,
1) with nominal bonds you know the exact cashflows in nominal terms but not in real terms
2) with IL gilts you know the exact cashflows in real terms, but not in nominal terms

With either type, to convert the cashflows from nominal to real or vice versa, future inflation needs to be guessed at. The breakeven inflation is given by the difference in yields at the time of purchase. For example, if nominal yields are 4% and real yields are 1%, then if future annualised inflation is 3% or above then ILG will 'win', otherwise the nominal gilt will win.

For example, ignoring accrued interest, you could use £100 to buy (prices from yieldgimp.com)

about 1.2 bonds (i.e., £100 units) of T45 (nominal gilt) which would give £4.22 coupons per year and £120 on maturity (in nominal terms)

Alternatively, you could use £100 to buy

1.1 bonds of TR45 (inflation linked gilt) which would give (real£)0.75 coupons per year and (real£)111 on maturity.

The nominal amounts with TR45 depend on the inflation between now and 2045. With 3% inflation, the maturing value would be £201 in today's money. The annual coupons would vary between £0.75 and £1.31 in today's money.

It is impossible to know beforehand which would be the better investment - breakeven inflation is about 3.3%, so if annualised inflation is greater than this then TR45 will be better, otherwise T45. However, the larger coupon means that the nominal bond would (probably) be better at providing regular income, while the ILG would (probably) be better at providing a lump sum in 20 years time. I note that there are other pairs of gilts with coupons of more similar values that might be better to compare than these two.