Index-Linked Gilts question

masonic

aroominyork said:

So ILGs are an insurance policy against higher than forecast inflation, and like all insurance policies you pay a premium. Presumably for ILGs it works something like - and this is only for illustrative purposes - if inflation is forecast to be 3% then anything between 2.95% and 3.05% is profit for the house. What is the spread and how does it work in practice?

You are unlikely to buy on the primary market, so it isn't really relevant what the Treasury is able to auction them for. On the secondary market, you can look at the relative YTM (with the caveat that coupons are also index linked for ILG). In the not so distant past, ILG were yielding inflation minus 2-4%, whereas nominals were yielding a little north of +1%. More recently you can get inflation plus 0.5-2% vs +3.5-5%. so the breakeven RPI/CPIH is not so different.

aroominyork

I'm struggling to interpret that, masonic. Does your answer explain the cost of the insurance to index link your gilt? In other words, the level over expected inflation where you will receive no benefit. Or am I wrong in likening this to an insurance policy because no-one is taking a cut for issuing the policy?

masonic

aroominyork said:

I'm struggling to interpret that, masonic. Does your answer explain the cost of the insurance to index link your gilt? In other words, the level over expected inflation where you will receive no benefit. Or am I wrong in likening this to an insurance policy because no-one is taking a cut for issuing the policy?

Yes, it's approximately the difference between the nominal YTM of a nominal vs index linked gilt, getting less accurate at either extreme of duration. For example, T28 (Aug) @ 0.5% vs TS28/TG28 (Jun/Oct) @ 3.9/3.7 gives a 3 year market forecast of inflation @ 3.3%pa. So if that comes to pass you will receive no benefit. If RPI is lower than that you will be worse off with index linked.

That is not considering tax/level of coupon. YMMV if investing unwrapped.

As RPI inflation has averaged 3.5% over the last 25 years, 4.3% over the last 10 years, and 2.8% over the historically abnormal post-GFC decade, it is not expensive insurance.

zagfles

aroominyork said:

I'm struggling to interpret that, masonic. Does your answer explain the cost of the insurance to index link your gilt? In other words, the level over expected inflation where you will receive no benefit. Or am I wrong in likening this to an insurance policy because no-one is taking a cut for issuing the policy?

You are wrong. It's nothing like an "insurance policy". The govt issues IL gilts at prevailing market rates (accounting for interest rate and inflation expectations) and they move with market sentiment while issued. There's no "insurance" element whatsoever. Govt revenues tend to increase with inflation (VAT is directly linked, income tax too as wages tend to move with inflation or more over the long term) so there's no real risk to the issuer. 

GeoffTF

aroominyork said:

So ILGs are an insurance policy against higher than forecast inflation, and like all insurance policies you pay a premium. Presumably for ILGs it works something like - and this is only for illustrative purposes - if inflation is forecast to be 3% then anything between 2.95% and 3.05% is profit for the house. What is the spread and how does it work in practice?

The price of an index linked gilt is decided by the market. The market has been bad at forecasting future interest rates and inflation rates. We will not know what future interest rates and inflation rates will be until they happen, and neither will the market or the central banks. The relative prices of index linked and conventional gilts will depend on how scared the market is of future inflation as much as what it thinks will happen.

GeoffTF

masonic said:

You are unlikely to buy on the primary market, so it isn't really relevant what the Treasury is able to auction them for.

Some platforms allow you to participate in gilt auctions. HL is one.

aroominyork

I'm thinking of buying T27 to get a feel for the process. I trade on Interactive Investor but track my investments on HL's watchlist. I added 1 unit of T27 to my HL watchlist and it shows the value as £1.01. That is the clean price, not the dirty price of £2.12, so is the watchlist not going to show the true/redeemable value of my holding? (ii's watchlist does the same.)

GeoffTF

aroominyork said:

I'm thinking of buying T27 to get a feel for the process. I trade on Interactive Investor but track my investments on HL's watchlist. I added 1 unit of T27 to my HL watchlist and it shows the value as £1.01. That is the clean price, not the dirty price of £2.12, so is the watchlist not going to show the true/redeemable value of my holding? (ii's watchlist does the same.)

HL correctly uses dirty prices to value my index linked gilt on my quarterly statements, but incorrectly uses the clean prices online. AJ Bell valued my holdings correctly when I had an account with them.

zagfles

aroominyork said:

I'm thinking of buying T27 to get a feel for the process. I trade on Interactive Investor but track my investments on HL's watchlist. I added 1 unit of T27 to my HL watchlist and it shows the value as £1.01. That is the clean price, not the dirty price of £2.12, so is the watchlist not going to show the true/redeemable value of my holding? (ii's watchlist does the same.)

It's a problem on most platforms with IL gilts, even when you buy them they show a massive capital loss because they use the clean price to value them. It can cause serious issues eg taking a TFLS from a pension, see Interactive Investor - calculation of 25% tax free cash when holding Index Linked Gilts — MoneySavingExpert Forum 

aroominyork

Hmmm... is there a way to link my Excel - the one I use for tracking my investments - to the dirty price shown somewhere on the web, so that my cell shows #units * dirty price = valuation ?