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ILG ladder query
Comments
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Fair enough........if you believe inflation over the next 5 years will be higher than the market expects, then IL gilts would indeed seem to be the way to go for you.
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One way to help make a decision is to model some relatively extreme scenarios to see what happens. For example, according to the lategenxer tool, for a 5 year ladder £100k will currently buy £22530 in nominal annual income or £19540 in inflation adjusted income.
If inflation falls to zero and holds there for 5 years (extreme, but unlikely) then the nominal ladder would deliver about £15k (nominal) more over the course of the ladder, i.e., 5*(22530-19540).
If inflation runs at 10% over the next 5 years (fairly extreme and possible, but who knows?), the inflation linked ladder would deliver about £6.6k (nominal) more (at 15% inflation, the ILG would outstrip the nominal ladder by £19k).
In other words, for a short ladder of 5 years, the effect of getting the choice wrong is not likely to be too severe.
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According to the BoE implied inflation yield curves (of 11 March) there is a strong gradient over the first few years since the spot implied inflation goes from 4.15% at a maturity of 2 years to 3.53% at 5 years. The market is, presumably, pricing in some rough inflation for the next couple of years.
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Theoretically, you are right…….but with the ladder in question, the devil is in the detail.
The breakeven figures given by those yield curves and sites such as giltsyield make some assumptions which don't necessarily apply to a gilt ladder built using this tool……
Compare the actual IL gilt ladder suggested by the tool in your first post to a conventional gilt ladder costing the same……then add up the payouts from the conventional ladder and then see how much the payouts from the IL ladder would need to increase by to break even over the life of the ladder.………
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Generally in life you pay extra for certainty so for most I suspect even if the expected return was marginally lower for the index linked ladder they might still consider it.
I think....0 -
No - Break even rate is coventional less ILG over the life - 5 years. One less t'other after 5 years is around 3.7%
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I think the other factor for me - as others have mentioned - is protection from inflation, possibly regardless of whether conventional gilts may be a better bet. I'm only looking at 5 years so perhaps it is somewhat academic.
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True, but then again if this certainty was the overriding priority, then you probably wouldn't be comparing conventional gilt ladders to index linked or worrying about breakeven numbers.
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Yes, if that is the main objective, you would go with ILG for sure…and I should maybe have highlighted that. I was just observing the technical factors which often affect the breakeven number that emerges and that these can impact B/E quite significantly at times. One aspect that some investors overlook is that holding ILG to maturity is important if the real yield at purchase is to be realised. The long duration and low coupon make them more volatile than equities at times, as we saw in 2022.
If you are looking sub 5 years as an inflation hedge primarily, then you should still get a modest real return overall…timing your purchase for any improvement in b/e or real yields is likely to be a matter of luck.1 -
They will indeed be held until maturity. Other half of the pot is in equities - which I don't need to draw on at present. Protection is not the overriding priority, the other being if the ILG ladder offers a better return overall than conventional gilts. Not sure if there is much in it over 5 years, so the protection offered by the ILG would appear to swing it.
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