Index-Linked Gilts question

masonic

What about the iShares up to 10 year ILG fund? Effective duration is quite reasonable at 4 years.

Linton

aroominyork said:

They sure are complicated, these ILGs. OK, I get the purpose of linking your returns to UK inflation and matching maturity to your expenditure, but if you want an easier way to go about it - proxying developed world inflation for the UK's and being less time specific - how good a solution is a global index/inflation linked bond fund such as Royal London's or Aberdeen's?

Looking at the RL Global IL Bond fund a quick bit of mental arithmetic suggests that they are something like 50% US.  I would see 3 areas of concern about the fund providing inflation linked returns when you come to sell:
1) currency risk
2) US inflation may be quite different from UK inflation.
3) And then you have the problem of volatility.  Over the past 3 years the fund fell in value by about 8% in Total Return terms.  This was because it contains a significant % of long dated bonds which are strongly affected by interest rate changes.

What are you trying to achieve? How can a global IL bond fund be a good solution to whatever problem would otherwise have led you to buying single IL Gilts?

aroominyork

Linton said:

aroominyork said:

They sure are complicated, these ILGs. OK, I get the purpose of linking your returns to UK inflation and matching maturity to your expenditure, but if you want an easier way to go about it - proxying developed world inflation for the UK's and being less time specific - how good a solution is a global index/inflation linked bond fund such as Royal London's or Aberdeen's?

Looking at the RL Global IL Bond fund a quick bit of mental arithmetic suggests that they are something like 50% US.  I would see 3 areas of concern about the fund providing inflation linked returns when you come to sell:
1) currency risk
2) US inflation may be quite different from UK inflation.
3) And then you have the problem of volatility.  Over the past 3 years the fund fell in value by about 8% in Total Return terms.  This was because it contains a significant % of long dated bonds which are strongly affected by interest rate changes.

What are you trying to achieve? How can a global IL bond fund be a good solution to whatever problem would otherwise have led you to buying single IL Gilts?

That's a good question which deserves a good answer. Unfortunately I don't have one. Just exploring, trying to learn (you thought bonds were complex? - try linkers) and to see whether they would be useful in my portfolio. 

Edit: But it leads to research on the level of correlation between inflation among developed countries, eg https://www.ons.gov.uk/economy/inflationandpriceindices/articles/globalinflation/1970to2022. You can choose whether to overlay the possibility of tariffs or other short-term factors sending the US or other countries on their own inflationary or disinflationary journeys.

zagfles

The usual reason for holding individual IL gilts is with the intention of holding them to maturity when the real value is known, and you don't need to worry about what's happening in the market (interest rates, inflation etc). Gilt funds are completely different. You have no guarantee whatsoever as they're invested in various gilts with different maturities and so gilt funds will move with the market, sometimes massively eg if interest rates rise as happened in 2022 causing gilt funds to plummet in value. 

The technical nitty gritty of IL gilts may be complicated but the basics aren't, you don't really need to worry about indexation lags and the technicalities of how the indexation works if you're looking at a mid-long term investment. Just check the clean price, if below 100 you know that you'll have a positive real return if you hold to maturity. 

OldScientist

aroominyork said:

Linton said:

aroominyork said:

They sure are complicated, these ILGs. OK, I get the purpose of linking your returns to UK inflation and matching maturity to your expenditure, but if you want an easier way to go about it - proxying developed world inflation for the UK's and being less time specific - how good a solution is a global index/inflation linked bond fund such as Royal London's or Aberdeen's?

Looking at the RL Global IL Bond fund a quick bit of mental arithmetic suggests that they are something like 50% US.  I would see 3 areas of concern about the fund providing inflation linked returns when you come to sell:
1) currency risk
2) US inflation may be quite different from UK inflation.
3) And then you have the problem of volatility.  Over the past 3 years the fund fell in value by about 8% in Total Return terms.  This was because it contains a significant % of long dated bonds which are strongly affected by interest rate changes.

What are you trying to achieve? How can a global IL bond fund be a good solution to whatever problem would otherwise have led you to buying single IL Gilts?

That's a good question which deserves a good answer. Unfortunately I don't have one. Just exploring, trying to learn (you thought bonds were complex? - try linkers) and to see whether they would be useful in my portfolio. 

Edit: But it leads to research on the level of correlation between inflation among developed countries, eg https://www.ons.gov.uk/economy/inflationandpriceindices/articles/globalinflation/1970to2022. You can choose whether to overlay the possibility of tariffs or other short-term factors sending the US or other countries on their own inflationary or disinflationary journeys.

Just a few thoughts

Individual inflation linked gilts held to maturity are good for providing known real cashflows. For example, buying TR35 (1.125% coupon, 1.5% yield, clean price of 96.38 as of end of 30 July) with £96.38 (edit: I've ignored accrued interest) will provide an index linked £1.125 per year and an index linked £100 on maturity. A collapsing ladder of maturing ILGs in retirement provides known inflation linked income.

Individual nominal gilts held to maturity provide a known nominal cashflow.

Nominal bond fund. Will hold a variety of bonds, sometimes with a defined range of maturities (e.g., under 5 year gilts). The NAV will vary with changes in yields (the amount of change dependent on the duration of the fund - which will also vary) with increasing yields leading to reduction in NAV and vice versa. Yields will tend to increase with inflation although, historically, that wasn't always the case. Weighted yield to maturity will give an idea of returns over the duration of the fund with longer duration funds having more volatility. Global funds will then be dependent on international yields.

Inflation linked bond funds are similar except that nominal returns are dependent on duration, real yields and inflation.

Funds are quite useful for generally reducing the overall volatility of a portfolio (since equities tend to have greater volatility) with shorter duration funds doing a better job. Whether inflation linked or nominal funds will be better is not easy to answer (there's a thread at https://www.bogleheads.org/forum/viewtopic.php?t=458806 that compares US TIPS and nominal bonds that appears to show little difference, about 20 bp annualised, over the last 20 or so years once combined with equities).

aroominyork

masonic said:

What about the iShares up to 10 year ILG fund? Effective duration is quite reasonable at 4 years.

zagfles said:

The usual reason for holding individual IL gilts is with the intention of holding them to maturity when the real value is known, and you don't need to worry about what's happening in the market (interest rates, inflation etc). Gilt funds are completely different. You have no guarantee whatsoever as they're invested in various gilts with different maturities and so gilt funds will move with the market, sometimes massively eg if interest rates rise as happened in 2022 causing gilt funds to plummet in value. 

iShares' factsheet states effective maturity of 5.24%. That's closer to TR31 (in green) than T29 (blue) but I have overlaid both. Is this an accurate representation of what has happened to the three assets' prices or is something missing, perhaps coupons on the individual ILGs?

Also, what does the fund increase of 12% in two years indicate? Anticipation of rising inflation?

OldScientist

aroominyork said:

masonic said:

What about the iShares up to 10 year ILG fund? Effective duration is quite reasonable at 4 years.

zagfles said:

The usual reason for holding individual IL gilts is with the intention of holding them to maturity when the real value is known, and you don't need to worry about what's happening in the market (interest rates, inflation etc). Gilt funds are completely different. You have no guarantee whatsoever as they're invested in various gilts with different maturities and so gilt funds will move with the market, sometimes massively eg if interest rates rise as happened in 2022 causing gilt funds to plummet in value. 

iShares' factsheet states effective maturity of 5.24%. That's closer to TR31 (in green) than T29 (blue) but I have overlaid both. Is this an accurate representation of what has happened to the three assets' prices or is something missing, perhaps coupons on the individual ILGs?

Also, what does the fund increase of 12% in two years indicate? Anticipation of rising inflation?

The price of the gilts is the clean real price, you have to add inflation to that to get the nominal value - which is (from June 2023 to June 2025) about 7.5%

The effect of the coupons (both 0.125%) will be relatively small, but add another 0.25% over two years.

So a total of just under 8% which is at least a bit closer.

The fund will also have held other gilts (some of which have now matured) that added to the NAV.

aroominyork

OldScientist said:

aroominyork said:

masonic said:

What about the iShares up to 10 year ILG fund? Effective duration is quite reasonable at 4 years.

zagfles said:

The usual reason for holding individual IL gilts is with the intention of holding them to maturity when the real value is known, and you don't need to worry about what's happening in the market (interest rates, inflation etc). Gilt funds are completely different. You have no guarantee whatsoever as they're invested in various gilts with different maturities and so gilt funds will move with the market, sometimes massively eg if interest rates rise as happened in 2022 causing gilt funds to plummet in value. 

iShares' factsheet states effective maturity of 5.24%. That's closer to TR31 (in green) than T29 (blue) but I have overlaid both. Is this an accurate representation of what has happened to the three assets' prices or is something missing, perhaps coupons on the individual ILGs?

Also, what does the fund increase of 12% in two years indicate? Anticipation of rising inflation?

The price of the gilts is the clean real price, you have to add inflation to that to get the nominal value - which is (from June 2023 to June 2025) about 7.5%

Ah, of course, as discussed a few posts ago.

zagfles

For a start as mentioned earlier the price of the individual gilts is probably the clean price so won't reflect the real increase in value. Secondly you can't compare individual gilts to gilt funds, particularly for short dated gilts, gilts are nothing like shares etc where there's no maturity date, you'd expect movements in share prices to be similar to funds holding those shares. Gilts have an end date, a maturity date where the value is known (real value for IL gilts). So how do funds operate? Do they hold till maturity and then buy 10 year gilts? Or do they sell eg 2 years before maturity and buy 8 year gilts? Either way they will have to constantly swap shorter dated gilts for longer dated ones. So gilt funds will behave differently to individual gilts of similar duration

aroominyork

zagfles said:

For a start as mentioned earlier the price of the individual gilts is probably the clean price so won't reflect the real increase in value. Secondly you can't compare individual gilts to gilt funds, particularly for short dated gilts, gilts are nothing like shares etc where there's no maturity date, you'd expect movements in share prices to be similar to funds holding those shares. Gilts have an end date, a maturity date where the value is known (real value for IL gilts). So how do funds operate? Do they hold till maturity and then buy 10 year gilts? Or do they sell eg 2 years before maturity and buy 8 year gilts? Either way they will have to constantly swap shorter dated gilts for longer dated ones. So gilt funds will behave differently to individual gilts of similar duration

Not sure that's right, at least not for conventional/non-linker gilts. If you look at the duration of a gilt index fund, about eight years, and overlay a gilt with similar duration, say TG33, they track each other closely (although obviously you have to swap your nominal gilt periodically for a longer duration).