Index-Linked Gilts question

zagfles

Linton said:

aroominyork said:

Linton said:

aroominyork said:

Back to the question of ILG index funds vs. individual ILGs. If you do not hold them to maturity, is the potential variance – the gain or loss caused by the clean price not following a straight line towards par – the same as with conventional gilts or do other factors come into play?

The price of any bond is fixed when you buy and fixed ( in either £ or real terms)  at maturity. Between those 2 fixed points the price is solely determined by the markets.

The main driver of the IL bond market is the interest rate for regular bonds. Clearly if interest rates were higher than expected inflation people would prefer to invest in the regular bonds and hence the price of IL bonds would decrease. If interest rates were low IL gilts would be seen as good investments and so more people would buy them pushing the price up.

IIRC prior to the recent bond crash long dated IL gilts were trading at a clean price of around £180. Once interest rates rose above expected inflation  the IL price quickly dropped to below par.

Or even £395 for a very long dated 2073 ILG.

PS  You say “Clearly if interest rates were higher than expected inflation people would prefer to invest in the regular bonds and hence the price of IL bonds would decrease.” Is that correct? If interest rates are say 5% and inflation is forecast at 2%, people would still buy linkers if they wanted to protect against inflation being higher than forecast. They would not be foregoing the return that regular gilts offer.

The £385 figure comes from old IL bonds using dirty pricing. This changed some time ago.

No it doesn't. The 2073 ILG is a new type which uses clean pricing, the clean price really did get up to almost £400. Complete madness. I guess it shows how much the price is driven by mandated investment policies of big players rather than common sense!

There's only 2 old style gilts left that use dirty pricing (or rather semi-dirty pricing - including the inflation uplift but not accrued coupon). 

aroominyork

Just an observation: Yieldgimp.com's data sheet for ILGs shows breakeven RPI of 3.0-3.2% in the long term (slightly higher in the short/medium term). That means CPI would need to undershoot RPI by more than 1% to meet the BoE's 2% inflation target. 

OldScientist

TG73 was introduced in 2021 so, as @zagfles said, is indeed a recent gilt. The price variation is solely due to changes in yield.

For example, for a 50 year bond with a 0.125% coupon the price varies with yield as follows (although I've used my own code, the spreadsheet function price can used to calculate this)

Yield(%)  Price
-2           284.0
-1           173.2
0            106.3
1            65.6
2            40.9

With such a small coupon, the modified duration is close to the maturity (ranging from 49.7 to 46.8 at yields of -2 and 2, respectively) and it is this that is a measure of sensitivity to changes in yields (i.e., a 0.1% change in yield would lead to roughly 4.9% change in price).

zagfles

aroominyork said:

Just an observation: Yieldgimp.com's data sheet for ILGs shows breakeven RPI of 3.0-3.2% in the long term (slightly higher in the short/medium term). That means CPI would need to undershoot RPI by more than 1% to meet the BoE's 2% inflation target. 

RPI average over the last 10 years was 4.6%

GeoffTF

aroominyork said:

Just an observation: Yieldgimp.com's data sheet for ILGs shows breakeven RPI of 3.0-3.2% in the long term (slightly higher in the short/medium term). That means CPI would need to undershoot RPI by more than 1% to meet the BoE's 2% inflation target. 

RPI has typically been about 1% more than CPI. See Chart 1.1.here:

https://obr.uk/docs/dlm_uploads/Working-paper-No2-The-long-run-difference-between-RPI-and-CPI-inflation.pdf

CPI has been above target in recent years, but has been below target in the past:

https://www.statista.com/statistics/306648/inflation-rate-consumer-price-index-cpi-united-kingdom-uk/

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?

US tariffs incoming! I've owned Royal London's hedged short duration global index linked bond fund in the past and am thinking about it again. It's about 45% US, 33% UK. Thoughts?

Linton

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?

US tariffs incoming! I've owned Royal London's hedged short duration global index linked bond fund in the past and am thinking about it again. It's about 45% US, 33% UK. Thoughts?

No thoughts at all.  My strategy is to accept that I have absolutely no reliable idea of what the future will bring so the best that can be done is to put together a portfolio whose overall asset allocations correspond to the objectives with as wide a diversification as reasonably possible.  Then let the world economy do as it will.

I have no objectives which lead to the need for a developed world  global bond fund.

masonic

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?

US tariffs incoming! I've owned Royal London's hedged short duration global index linked bond fund in the past and am thinking about it again. It's about 45% US, 33% UK. Thoughts?

What attracts you to US inflation linked bonds rather than going purely UK? Trying to capitalise on US inflation stoked by the tariffs? Have you been able to get your head around the US market and whether those bonds represent a low enough breakeven inflation rate?

aroominyork

masonic said:

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?

US tariffs incoming! I've owned Royal London's hedged short duration global index linked bond fund in the past and am thinking about it again. It's about 45% US, 33% UK. Thoughts?

What attracts you to US inflation linked bonds rather than going purely UK? Trying to capitalise on US inflation stoked by the tariffs? Have you been able to get your head around the US market and whether those bonds represent a low enough breakeven inflation rate?

I hold a mix of UK and global bonds and want to shorten UK duration from the index fund's length, and am mulling the inflation link. Duration is less of an issue non-UK and, yes, tariff inflation has me looking at that fund. US markets generally seem in denial about what is likely to come. Good point about breakdown rate though - any info you can offer?

PS The breakeven rate is 2.48% on a five year Treasury, which is below current inflation. That looks an attractive enough proposition. 

masonic

aroominyork said:

masonic said:

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?

US tariffs incoming! I've owned Royal London's hedged short duration global index linked bond fund in the past and am thinking about it again. It's about 45% US, 33% UK. Thoughts?

What attracts you to US inflation linked bonds rather than going purely UK? Trying to capitalise on US inflation stoked by the tariffs? Have you been able to get your head around the US market and whether those bonds represent a low enough breakeven inflation rate?

I hold a mix of UK and global bonds and want to shorten UK duration from the index fund's length, and am mulling the inflation link. Duration is less of an issue non-UK and, yes, tariff inflation has me looking at that fund. US markets generally seem in denial about what is likely to come. Good point about breakdown rate though - any info you can offer?

Well I know that the 5 year TIPS yield is currently 1.4% and the 5 year Treasury 3.8%, and the 5 year average expected US CPI rate was 2.4% as of Monday. So if you think that figure didn't price in what happened overnight there's a chance short-dated TIPS will give you a better overall return. But I can't see the attraction over ILG, when they are pegged to a more generous inflation measure, don't carry any currency/hedging risk, and don't carry any risk of being caught up in collateral damage from further financial sanctions, like the threat of conversion to 100 year Treasuries.

I've been dialling down my exposure to US bonds. It is currently half of what it at the start of the year (all hedged and none of it index linked). I see no upside, only potential downsides.