Explain Gilts/Bonds to me like I am 5 years old please?

GenX0212

SnowMan said:

GenX0212 said:

SnowMan said:

SVaz said:

Am I right to assume that buying them at or below face value is the only sensible way to go?

People who bought them well over face value with little coupons would lose out even if held to maturity, wouldn’t they?  Even with high inflation?  

If an index linked gilt has a clean price of exactly £100 ('par' in the jargon) it just means that the real yield (gross redemption yield) is equal to the coupon, because in purchasing that gilt you would get your money back plus inflation at maturity, and on top would have the annual coupon.

T38, which has a 1.75% coupon, had a clean price of 99.38 at yesterday's close and the calculated real yield was 1.80%. So the real yield was slightly above 1.75% because it is priced at marginally below par. If the price went up to 100 the real yield would reduce to about 1.75% i.e the coupon.

T32 (1.25% coupon) is priced at 101.014 at yesterday's close which results in a calculated real yield of 1.1%. The fact that it is priced above par is not a reason not to buy it. Requiring a real yield above 1.1% would be a reason not to buy it.

In practice most index linked gilts have a low coupon as the coupon is usually set at issue to be about the real yield at issue so that they can be initially priced around par. So generally most index linked gilts are (clean) priced below par currently as real yields are generally above zero and above the low coupon rates. 

Worth adding that with something like T30I the price of £340+ reflects the inflation indexation that has already been applied, because in this case the original £100 was issued in year 2000

Yes that's one of the two 8 month lagged index linked gilts that still exists (along with T2IL). It was actually issued in June 1992 so the indexation was from then (with an 8 month lag). As you say there is no clean price for those two index linked gilts just the price including indexation to date. 

Those two index linked gilts are best avoided in my view. I understand amongst other things the spreads on those are quite high because there is limited trading going on in them.

Would you avoid even if planning to hold to maturity, if so what would be the reason?

The price in the last couple of years has hovered at around £340 but was £360-£370 before that - presumably because it gave a good solid return whist interest rates were very low. 

SnowMan

GenX0212 said:

SnowMan said:

GenX0212 said:

SnowMan said:

SVaz said:

Am I right to assume that buying them at or below face value is the only sensible way to go?

People who bought them well over face value with little coupons would lose out even if held to maturity, wouldn’t they?  Even with high inflation?  

If an index linked gilt has a clean price of exactly £100 ('par' in the jargon) it just means that the real yield (gross redemption yield) is equal to the coupon, because in purchasing that gilt you would get your money back plus inflation at maturity, and on top would have the annual coupon.

T38, which has a 1.75% coupon, had a clean price of 99.38 at yesterday's close and the calculated real yield was 1.80%. So the real yield was slightly above 1.75% because it is priced at marginally below par. If the price went up to 100 the real yield would reduce to about 1.75% i.e the coupon.

T32 (1.25% coupon) is priced at 101.014 at yesterday's close which results in a calculated real yield of 1.1%. The fact that it is priced above par is not a reason not to buy it. Requiring a real yield above 1.1% would be a reason not to buy it.

In practice most index linked gilts have a low coupon as the coupon is usually set at issue to be about the real yield at issue so that they can be initially priced around par. So generally most index linked gilts are (clean) priced below par currently as real yields are generally above zero and above the low coupon rates. 

Worth adding that with something like T30I the price of £340+ reflects the inflation indexation that has already been applied, because in this case the original £100 was issued in year 2000

Yes that's one of the two 8 month lagged index linked gilts that still exists (along with T2IL). It was actually issued in June 1992 so the indexation was from then (with an 8 month lag). As you say there is no clean price for those two index linked gilts just the price including indexation to date. 

Those two index linked gilts are best avoided in my view. I understand amongst other things the spreads on those are quite high because there is limited trading going on in them.

Would you avoid even if planning to hold to maturity, if so what would be the reason?

The price in the last couple of years has hovered at around £340 but was £360-£370 before that - presumably because it gave a good solid return whist interest rates were very low. 

Yes I would personally avoid. Not saying it would be a disaster to buy. But why not buy one of the more modern 3 month lagged gilts of similar term? As well as the spread there is the issue of indexation being less up to date because of the longer lag.  

OldScientist

SVaz said:

What is the break even point on conventional vs IL Gilts?
I priced up both for my ladder and the IL Gilts were over 50% more than the conventional with tiny coupons. 

I thought that 50% difference would be better off left invested and would probably double in the same timeframe but then I’m not relying on income from that Sipp once I’m 67. 

For a nominal and inflation linked gilt of the same maturity, the difference between the yields is the breakeven inflation ('implied inflation' using BoE nomenclature or 'expected inflation' for the US Treasury) - i.e., the inflation required to produce an exactly equal outcome.

For a nominal gilt, the cashflows (i.e., coupons and maturing value) are, in nominal terms, known in advance, but the real values are unknown.

For an ILG, the real cashflows are known in advance but the nominal ones are not.

It is only afterwards that which of them would have been the best investment is known.

SimonSeys

Interesting thread.  Thanks to the OP for starting and everyone else for contributing. 

Gilts are not for me at the moment, but I’m wondering which platforms everyone is using to buy (and sell).  Any recommendations? 

Alexland

SimonSeys said:

Gilts are not for me at the moment, but I’m wondering which platforms everyone is using to buy (and sell).  Any recommendations? 

I've been shopping around for a SIPP to directly hold IL Gilts (to build a ladder to roughly lock in current annuity rates) and have settled on AJ Bell as it's possible to trade them online for the normal £5 fee (other places seem to charge more for telephone dealing, high value trades, etc) and the account ongoing fee cap (for non-funds) is only £120 pa. As a bonus I've also heard on this forum that they show the dirty price in the account valuations which is less depressing than looking at the clean price.

I've been with AJ Bell for other accounts for years but am new to holding IL Gilts there and am awaiting a partial transfer from my workplace pension (which I recently switched to an IL Gilt fund) to complete before buying. I'm hoping that eventually the saving in ongoing charges will cover the upfront trade spreads.

My bigger capped SIPP is with Fidelity where it doesn't seem possible to buy IL Gilts directly although maybe I could use an ETF to hold some with on average shorter durations than I plan to hold in my AJ Bell SIPP. At the moment that account is mostly in equities.

For a GIA/ISA then iWeb (to be rebranded as Scottish Widows) is probably fine but I understand they show clean prices in their valuations.

SimonSeys

Thanks.  I have accounts with Vanguard and L&G, but neither offer the opportunity to buy gilts directly, just an ETF, which I’m not interested in.  Will half-heartedly investigate AJ Bell (half heartedly as I’m not in a rush)

coyrls

Alexland said:

SimonSeys said:

Gilts are not for me at the moment, but I’m wondering which platforms everyone is using to buy (and sell).  Any recommendations? 

I've been shopping around for a SIPP to directly hold IL Gilts (to build a ladder to roughly lock in current annuity rates) and have settled on AJ Bell as it's possible to trade them online for the normal £5 fee (other places seem to charge more for telephone dealing, high value trades, etc) and the account ongoing fee cap (for non-funds) is only £120 pa. As a bonus I've also heard on this forum that they show the dirty price in the account valuations which is less depressing than looking at the clean price.

I've been with AJ Bell for other accounts for years but am new to holding IL Gilts there and am awaiting a partial transfer from my workplace pension (which I recently switched to an IL Gilt fund) to complete before buying. I'm hoping that eventually the saving in ongoing charges will cover the upfront trade spreads.

My bigger capped SIPP is with Fidelity where it doesn't seem possible to buy IL Gilts directly although maybe I could use an ETF to hold some with on average shorter durations than I plan to hold in my AJ Bell SIPP. At the moment that account is mostly in equities.

For a GIA/ISA then iWeb (to be rebranded as Scottish Widows) is probably fine but I understand they show clean prices in their valuations.

Note that where a telephone trade is necessary because the trade can't be made online, my experience with both ii and Halifax Share Trading is that they charge the online trading fee not the telephone fee.  Since my first IL Gilt trades, both II and Halifax Share Trading (and iWeb where I subsequently moved) now offer online IL Gilt trades.  Although lengthy, I actually preferred telephone trading, as you knew the price you were buying at, with online trading you don't get to see the price before you buy.

Alexland

coyrls said:

Note that where a telephone trade is necessary because the trade can't be made online, my experience with both ii and Halifax Share Trading is that they charge the online trading fee not the telephone fee.  Since my first IL Gilt trades, both II and Halifax Share Trading (and iWeb where I subsequently moved) now offer online IL Gilt trades.  Although lengthy, I actually preferred telephone trading, as you knew the price you were buying at, with online trading you don't get to see the price before you buy.

I knew that iWeb honoured the normal price (they are not accepting new SIPPs) but looking at the full charges PDF at interactive investor I expected to pay both the £49 telephone fee and perhaps their £40 fee for trades over £100k.

When accessing TR50 on the below II page logged out it shows a trade button that goes to the login screen but after logging in then the same page says "This instrument can only be traded via phone"
https://www.ii.co.uk/bonds/0-index-linked-treasury-gilt-2050/LSE:TR50

Originally I was thinking of just dumping it all in TR50 as it has the best YTM and is hopefully a mid point in my retirement but it would be more sensible to spread the money in maybe 5 year intervals during my retirement using an amortisation based withdrawal pattern. However it might not be worth being too precise as if stock markets ever crashed enough and/or IL gilt prices rose enough then I might be tempted to cash them all in again as it wouldn't be attractive to hold them with with low or negative YTM.

poseidon1

SnowMan said:

GenX0212 said:

SnowMan said:

GenX0212 said:

SnowMan said:

SVaz said:

Am I right to assume that buying them at or below face value is the only sensible way to go?

People who bought them well over face value with little coupons would lose out even if held to maturity, wouldn’t they?  Even with high inflation?  

If an index linked gilt has a clean price of exactly £100 ('par' in the jargon) it just means that the real yield (gross redemption yield) is equal to the coupon, because in purchasing that gilt you would get your money back plus inflation at maturity, and on top would have the annual coupon.

T38, which has a 1.75% coupon, had a clean price of 99.38 at yesterday's close and the calculated real yield was 1.80%. So the real yield was slightly above 1.75% because it is priced at marginally below par. If the price went up to 100 the real yield would reduce to about 1.75% i.e the coupon.

T32 (1.25% coupon) is priced at 101.014 at yesterday's close which results in a calculated real yield of 1.1%. The fact that it is priced above par is not a reason not to buy it. Requiring a real yield above 1.1% would be a reason not to buy it.

In practice most index linked gilts have a low coupon as the coupon is usually set at issue to be about the real yield at issue so that they can be initially priced around par. So generally most index linked gilts are (clean) priced below par currently as real yields are generally above zero and above the low coupon rates. 

Worth adding that with something like T30I the price of £340+ reflects the inflation indexation that has already been applied, because in this case the original £100 was issued in year 2000

Yes that's one of the two 8 month lagged index linked gilts that still exists (along with T2IL). It was actually issued in June 1992 so the indexation was from then (with an 8 month lag). As you say there is no clean price for those two index linked gilts just the price including indexation to date. 

Those two index linked gilts are best avoided in my view. I understand amongst other things the spreads on those are quite high because there is limited trading going on in them.

Would you avoid even if planning to hold to maturity, if so what would be the reason?

The price in the last couple of years has hovered at around £340 but was £360-£370 before that - presumably because it gave a good solid return whist interest rates were very low. 

Yes I would personally avoid. Not saying it would be a disaster to buy. But why not buy one of the more modern 3 month lagged gilts of similar term? As well as the spread there is the issue of indexation being less up to date because of the longer lag.  

This brief dialogue, identifying the fact that not all index linked gilts are created equal, is a prime example of why they are on a different level of complexity compared to the fixed coupon variants.

How many existing index linked gilt investors let alone newbies would be aware of this difference in the lag period for these older gilts or appreciate the wider spread due to much lower trading volumes? 

The regulators are of the view that gilt investing does not require you to be a sophisticated investor. Certainly as regard 'linkers' I beg to differ.

SVaz

With HL,  you get 10 seconds to accept or deny the price that flashes up.