Donate to Remove ads

Got a credit card? use our Credit Card & Finance Calculators

Thanks to johnstevens77,Bhoddhisatva,scotia,Anonymous,Cornytiv34, for Donating to support the site

Inflation Linked Bonds: Passive or near-passive

Index tracking funds and ETFs
Newroad
Lemon Quarter
Posts: 1090
Joined: November 23rd, 2019, 4:59 pm
Has thanked: 17 times
Been thanked: 341 times

Inflation Linked Bonds: Passive or near-passive

#331594

Postby Newroad » August 7th, 2020, 5:04 pm

Hi All.

Currently, the bond holdings I have in various ISAs, JISAs & SIPPs are split 50/50 passive/active, with VAGP and an Investment Trust (HDIV, CMHY and IPE respectively).

I can see a time in the future when it might pay to jump ship, with the passive component (and possibly, the active component too) to an investment vehicle which invests wholly or predominantly in global inflation-linked bonds.

Anybody know of one or more suitable vehicles, preferably ETF or Investment Trust?

Yes, I know there is a timing issue - who knows whether I can time it right? Also, sorry if this is the wrong forum to post in - wasn't sure which the right one was if so.

Regards, Newroad

dealtn
Lemon Half
Posts: 6072
Joined: November 21st, 2016, 4:26 pm
Has thanked: 441 times
Been thanked: 2324 times

Re: Inflation Linked Bonds: Passive or near-passive

#331616

Postby dealtn » August 7th, 2020, 7:04 pm

Newroad wrote:
I can see a time in the future when it might pay to jump ship, with the passive component (and possibly, the active component too) to an investment vehicle which invests wholly or predominantly in global inflation-linked bonds.



What does that time look like? Personally I can't see a time close enough in the future where real yields are likely to be sufficiently high to make that an attractive investment. I am interested in what level of real yield you, or others, would be comfortable with before investing in this asset class (let alone paying fees to someone else to do it for you).

Newroad
Lemon Quarter
Posts: 1090
Joined: November 23rd, 2019, 4:59 pm
Has thanked: 17 times
Been thanked: 341 times

Re: Inflation Linked Bonds: Passive or near-passive

#331619

Postby Newroad » August 7th, 2020, 7:28 pm

It's a fair question, dealtn.

To initially answer, I'll quote (US Supreme Court Justice) Potter Stewart: "I'll know it when I see it". Of course, that may be too late to do anything about it - but at least, by considering it in advance, I will be well placed to act if I see evidence of it ahead of the curve and am willing to risk action based on that.

With slightly more granularity, some semi-rhetoric questions

  • What will governments (in particular) do to erode the debt created from the last two crises: tax/tighten, explicit default, or implicit default (inflation)? The first is politically difficult, the second almost unthinkable for a Western government which leaves the third as the one likely to pick up most of the slack at some point (if it can be engineered - Japan says it may not be able to be).
  • What will consumers do when confidence returns, e.g. in the event of a proven vaccine and/or effective anti-virals? With the amount of money sloshing around, if the velocity starts picking up, what else but inflation?
  • What will companies do, given the problems that just-in-time supply chains have experienced during the last/current crisis? Likely onshore some/all production, leading to safe(r) supply chains but relative inefficiency - which will likely lead to higher prices - inflation.

So, whether it comes and whether I'm good enough to see it in advance is an open question, but I'd like to have thought it through and be ready if I do.

Regards, Newroad

dealtn
Lemon Half
Posts: 6072
Joined: November 21st, 2016, 4:26 pm
Has thanked: 441 times
Been thanked: 2324 times

Re: Inflation Linked Bonds: Passive or near-passive

#331624

Postby dealtn » August 7th, 2020, 7:54 pm

Newroad wrote:It's a fair question, dealtn.

To initially answer, I'll quote (US Supreme Court Justice) Potter Stewart: "I'll know it when I see it". Of course, that may be too late to do anything about it - but at least, by considering it in advance, I will be well placed to act if I see evidence of it ahead of the curve and am willing to risk action based on that.

With slightly more granularity, some semi-rhetoric questions

  • What will governments (in particular) do to erode the debt created from the last two crises: tax/tighten, explicit default, or implicit default (inflation)? The first is politically difficult, the second almost unthinkable for a Western government which leaves the third as the one likely to pick up most of the slack at some point (if it can be engineered - Japan says it may not be able to be).
  • What will consumers do when confidence returns, e.g. in the event of a proven vaccine and/or effective anti-virals? With the amount of money sloshing around, if the velocity starts picking up, what else but inflation?
  • What will companies do, given the problems that just-in-time supply chains have experienced during the last/current crisis? Likely onshore some/all production, leading to safe(r) supply chains but relative inefficiency - which will likely lead to higher prices - inflation.

So, whether it comes and whether I'm good enough to see it in advance is an open question, but I'd like to have thought it through and be ready if I do.

Regards, Newroad


No problem with wanting to buy assets that provide you with a benefit if inflation rises. But thats not my question. It is all about price. Consider the UK for instance. Why buy an inflation linked bond that is priced at close to 300 when the payout at maturity is just 100? Now if it was priced at 100, and I was worried about inflation, that's a whole different story.

So my question is at what level of real yield are you comfortable buying. Would negative real yields, and a reduction in purchasing power if held to maturity, still be attractive enough over other assets?

Newroad
Lemon Quarter
Posts: 1090
Joined: November 23rd, 2019, 4:59 pm
Has thanked: 17 times
Been thanked: 341 times

Re: Inflation Linked Bonds: Passive or near-passive

#331625

Postby Newroad » August 7th, 2020, 8:07 pm

Sorry, dealtn.

Your original question, "What does that time look like?", was not clear.

At present, I am only musing on the vehicle(s) were I to pull the trigger. As to when to pull the trigger, I have no fixed idea on what metrics to apply (hence the bit about "knowing it when I see it").

In short, if I could identify it as high probability even slightly in advance, I would ideally like to

  • For the passive component of our investments, move from VAGP to an inflation linked equivalent, were it to exist, and
  • For the active component of our investments, put it in an Investment Trust whose managers can do either (inflation linked or non inflation linked) but have a pre-disposition to the former

It might be that going early costs in the short term, but if and when it starts, the inflation genie might be hard to put back in the bottle, if there was any governmental incentive to do so in the first place.

All this is a bit pie-in-the-sky at present though, hence the initial focus on the art of the possible as to what vehicle(s) to putatively use.

Regards, Newroad

PS Before anyone suggests it, I have no interest in the "Barbarous Relic" ;)

dealtn
Lemon Half
Posts: 6072
Joined: November 21st, 2016, 4:26 pm
Has thanked: 441 times
Been thanked: 2324 times

Re: Inflation Linked Bonds: Passive or near-passive

#331629

Postby dealtn » August 7th, 2020, 8:38 pm

Newroad wrote:Sorry, dealtn.

Your original question, "What does that time look like?", was not clear.


Apologies my phrasing was poor. What does the the market look like at the time you are imaging (your phrase was "I can see a time in the future...").

My thinking is that due to negative real yields the current time looks (to me) a poor one to be buying inflation linked bonds (specifically in the UK, but that holds elsewhere too).

In a world where inflation threats appear to have increased and even more people are forming an opinion that inflation is something that needs protecting from, then real yields are likely to be even lower.

So my question was what does this world look like that you can see in the future and what do you think the pricing of the products you are considering will look like then? And of course I am interested in other people's considerations too.

Like all investment (and consumption) strategies one of the most important considerations is "what is the price?" That holds whether the strategy is passive or active. So my considerations would extend to looking at what other asset classes are likely to do under the scenario you are looking to protect, or benefit, from. And, of course, how are they priced?

So if my concern was that inflation might lead to prices doubling in say 10 years, I would be looking at what that would mean for my purchasing power, but also what are the entry and exit prices for my assets under such a scenario? For instance 100 pounds would only buy 50 pounds equivalent over that period, but if inflation bonds (in real terms) went from 150 to 100 and I invested in these I would be able to buy 66 pounds (not 100). An alternative might be property (only as an example) that was currently priced at 100 but might rise to 200 mimicking inflation and investing here preserves the pourchasing power. A commodity fund might be priced at 100 and increase to 180, and selling would give you 90 pounds of equivalent to today spending power.

So whilst I don't have any recommendations for inflation linked funds of either passive or active persuasion, I do think the broader question of how the world looks (and how markets are priced) are relevant.

Newroad
Lemon Quarter
Posts: 1090
Joined: November 23rd, 2019, 4:59 pm
Has thanked: 17 times
Been thanked: 341 times

Re: Inflation Linked Bonds: Passive or near-passive

#331632

Postby Newroad » August 7th, 2020, 8:47 pm

Completely agreed, dealtn.

But that is then next question, then "when" (and maybe, the "if").

The first question, for me at least, is the "how" - only due to preparedness.

Regards, Newroad

Alaric
Lemon Half
Posts: 6035
Joined: November 5th, 2016, 9:05 am
Has thanked: 20 times
Been thanked: 1400 times

Re: Inflation Linked Bonds: Passive or near-passive

#331636

Postby Alaric » August 7th, 2020, 9:20 pm

dealtn wrote: It is all about price. Consider the UK for instance. Why buy an inflation linked bond that is priced at close to 300 when the payout at maturity is just 100?


Can you cite a bond where this is true? Surely all UK inflation linked bonds have a maturity value formula on the lines of 100 * (Index at maturity) / (index at issue). So at any moment, you don't actually know the maturity value in cash terms.

1nvest
Lemon Quarter
Posts: 4323
Joined: May 31st, 2019, 7:55 pm
Has thanked: 680 times
Been thanked: 1316 times

Re: Inflation Linked Bonds: Passive or near-passive

#331645

Postby 1nvest » August 7th, 2020, 10:37 pm

Newroad wrote:With slightly more granularity, some semi-rhetoric questions

  • What will governments (in particular) do to erode the debt created from the last two crises: tax/tighten, explicit default, or implicit default (inflation)? The first is politically difficult, the second almost unthinkable for a Western government which leaves the third as the one likely to pick up most of the slack at some point (if it can be engineered - Japan says it may not be able to be)
.

The debt isn't a issue. Fundamentally the more recent 'high' debt is comparable to what it was in 2008 - pre financial crisis. Back then the UK debt was around £0.5T and cost around 5%/year to service. Since then there's been around 33% inflation, so £0.66Tn inflation adjusted, but where that debt was bought up by the BoE printing money, whilst the Treasury sold new Gilts that pay around half the interest rate. The BoE returns all interest the Treasury pays on the Gilts that the BoE hold ... back to the Treasury. The newer gilts are also phased over a longer period of time. So of around £2Tn recent debt, the BoE holds around a third, and the remainder cost perhaps 2.5% to service, 1.3Tn x 2.5% = £32Bn to service, compared to 0.66Tn x 5% = £33Bn had things not changed, and where much of the debt will deflate due to inflation over the years before maturity.

The BoE could tear up all of the gilts it holds and the UK debt would shrink by a third at the swoosh of a penstroke. But in retaining them then that reserves the BoE option to sell them back into the market should circumstances depict that to be the appropriate course of action. We've moved from a era of using interest rates being raised/lowered to navigate the economy, to where the BoE can print to buy gilts or sell gilts to navigate the economy. When a big buyer buys gilts, so pension funds etc. on seeing higher bond values will typically reduce bonds to buy stocks - pushing share prices higher.

1nvest
Lemon Quarter
Posts: 4323
Joined: May 31st, 2019, 7:55 pm
Has thanked: 680 times
Been thanked: 1316 times

Re: Inflation Linked Bonds: Passive or near-passive

#331646

Postby 1nvest » August 7th, 2020, 10:57 pm

dealtn wrote:No problem with wanting to buy assets that provide you with a benefit if inflation rises. But thats not my question. It is all about price. Consider the UK for instance. Why buy an inflation linked bond that is priced at close to 300 when the payout at maturity is just 100? Now if it was priced at 100, and I was worried about inflation, that's a whole different story.

So my question is at what level of real yield are you comfortable buying. Would negative real yields, and a reduction in purchasing power if held to maturity, still be attractive enough over other assets?

Sometimes, and particularly at present, it isn't appropriate to hold to maturity.

From a very quick look, the recent 12 years 3 month Index Linked Gilt priced to a -2.31% real yield, if held for 3.66 years and the yield curve remained the exact same, would be priced to a -2.94% real yield as per the current 8 year 7 month ILG yield, and have gained 6% capital gain, 1.6% annualised - which offsets part of the -2.3% negative yield factor. So of the order inflation - 0.7%.

A form of 3.66 years insurance cost (0.2%/year) where if inflation rages, the holding keeps up with that. Given Covid, Brexit, largescale QE ...etc. that seems a really low insurance cost to cover if the Pound collapsed and inflation raged up at 20% levels or whatever.

The price just reflects the amount of inflation already priced in, that will generally increase as more time/inflation is added in.

richfool
Lemon Quarter
Posts: 3492
Joined: November 19th, 2016, 2:02 pm
Has thanked: 1195 times
Been thanked: 1280 times

Re: Inflation Linked Bonds: Passive or near-passive

#331650

Postby richfool » August 7th, 2020, 11:13 pm

Newroad wrote:Hi All.

Currently, the bond holdings I have in various ISAs, JISAs & SIPPs are split 50/50 passive/active, with VAGP and an Investment Trust (HDIV, CMHY and IPE respectively).

I can see a time in the future when it might pay to jump ship, with the passive component (and possibly, the active component too) to an investment vehicle which invests wholly or predominantly in global inflation-linked bonds.

Anybody know of one or more suitable vehicles, preferably ETF or Investment Trust?

Yes, I know there is a timing issue - who knows whether I can time it right? Also, sorry if this is the wrong forum to post in - wasn't sure which the right one was if so.

Regards, Newroad

Hi Newroad, Have you had a look at the likes of Personal Assets (PNL) and Capital Gearing trust (CGT)? They hold a proportion of US TIPS and UK index linked gilts. They are investment trusts in the Flexible (multi-asset) sector.

https://www.hl.co.uk/shares/shares-sear ... p12.50-ord

https://www.hl.co.uk/shares/shares-sear ... 25p-shares

JohnW
Lemon Slice
Posts: 506
Joined: June 1st, 2019, 7:00 am
Has thanked: 5 times
Been thanked: 176 times

Re: Inflation Linked Bonds: Passive or near-passive

#331662

Postby JohnW » August 8th, 2020, 6:43 am

dealtn wrote:Personally I can't see a time close enough in the future where real yields are likely to be sufficiently high to make that an attractive investment.

Many would agree they are not attractive now, I think you’re saying that. What asset class would you say is more attractive now, if any?

1nvest
Lemon Quarter
Posts: 4323
Joined: May 31st, 2019, 7:55 pm
Has thanked: 680 times
Been thanked: 1316 times

Re: Inflation Linked Bonds: Passive or near-passive

#331705

Postby 1nvest » August 8th, 2020, 11:39 am

Split the pot in half. With one half a third each domestic stock (UK), US stock (primary reserve currency), Gold (global currency and a commodity). The other half drop into a 5 year Gilt ladder.

For a US investor along similar lines indicates a >4% real (factoring in that domestic and global reserve currencies are one and the same for a US investor).

Same sort of figures/progression occurs for UK and Japan since 1972. Longer term history for the UK also sees that holding further back in time, but with the caveat that free floating silver was held instead of gold prior to 1972 after which the price of gold was permitted to free-float.

Suggest 2.4% PWR/year (0.2%/month) [Perpetual withdrawal rate] providing being held cost/tax efficiently. Historically in the average case that also saw a further 2% real annualised growth rate.

JohnW
Lemon Slice
Posts: 506
Joined: June 1st, 2019, 7:00 am
Has thanked: 5 times
Been thanked: 176 times

Re: Inflation Linked Bonds: Passive or near-passive

#331709

Postby JohnW » August 8th, 2020, 11:51 am

dealtn wrote:So my question is at what level of real yield are you comfortable buying. Would negative real yields, and a reduction in purchasing power if held to maturity, still be attractive enough over other assets?

Definitely attractive enough for lots of people, particularly those whose portfolio is without direct property, so just stocks and bonds. The stocks promise a higher return with volatility, and the bonds offer more stability of value with lower return; they both have a place for some people. And if you’re going to hold bonds, nominal bonds offer compensation for anticipated inflation - that’s built into the coupon, but if you want compensation for unanticipated inflation then you’d want some inflation linked bonds. The tricky part is: how much of either? If you thought unanticipated inflation would wreak more havoc for you than inflation below expectations or even deflation, then you might choose to have more inflation linked bonds than nominal bonds. Personal capital is seen to have some inflation protection: your wages go up with inflation, roughly; and real estate might too. Without those you might want some linkers, as unattractive as their yield might be.

1nvest
Lemon Quarter
Posts: 4323
Joined: May 31st, 2019, 7:55 pm
Has thanked: 680 times
Been thanked: 1316 times

Re: Inflation Linked Bonds: Passive or near-passive

#331713

Postby 1nvest » August 8th, 2020, 12:08 pm

Looking back at the rising/high inflation/interest rate years of the 1960's/70's, a 50/50 barbell of short dated and 20 year gilt held up relatively well considering 4 years of around 15% inflation and one year of around 25% inflation
Image
In the early/mid 1970's when inflation did spike, T-Bill (short dated Gilt) minus inflation figures saw a sharp rise in the negative direction (negative real yields), which is often a time when gold does well - and which it did over those years.

If you'd held shorter dated gilts, removed the longer dated gilts, then combined with gold you'd have done well. Stocks struggled, broadly just offset inflation across 1960 to mid 1970's when dividends were being reinvested.

Subsequently, stocks and bonds did well, starting from relatively high 1970's yields and broadly seeing yields progressively decline over the 1980's/1990's. Gold lagged, but rebalancing saw more ounces of gold being accumulated over those decades, and that more recently are again floating the portfolio.

Newroad
Lemon Quarter
Posts: 1090
Joined: November 23rd, 2019, 4:59 pm
Has thanked: 17 times
Been thanked: 341 times

Re: Inflation Linked Bonds: Passive or near-passive

#331759

Postby Newroad » August 8th, 2020, 4:25 pm

Hi Richfool.

richfool wrote:Hi Newroad, Have you had a look at the likes of Personal Assets (PNL) and Capital Gearing trust (CGT)? They hold a proportion of US TIPS and UK index linked gilts. They are investment trusts in the Flexible (multi-asset) sector.


I know of them, but haven't looked at either in detail. In a different type of portfolio to mine, more mixed, less segmented, something like CGT make may sense. However, I prefer clear delineation as much as practical (I know, for example, my Global Equity Investment Trusts don't hold all equities all the time) - whereas for my purposes, CGT is neither fish nor fowl.

This should not be construed as either praise or criticism of CGT.

Regards, Newroad

dealtn
Lemon Half
Posts: 6072
Joined: November 21st, 2016, 4:26 pm
Has thanked: 441 times
Been thanked: 2324 times

Re: Inflation Linked Bonds: Passive or near-passive

#331778

Postby dealtn » August 8th, 2020, 6:23 pm

Alaric wrote:
dealtn wrote: It is all about price. Consider the UK for instance. Why buy an inflation linked bond that is priced at close to 300 when the payout at maturity is just 100?


Can you cite a bond where this is true? Surely all UK inflation linked bonds have a maturity value formula on the lines of 100 * (Index at maturity) / (index at issue). So at any moment, you don't actually know the maturity value in cash terms.


Apologies. I worked in the industry for too long as a linker market maker. It is convention to quote all the new style index linked bonds in real, that is non-inflation adjusted prices. One of the main reasons is precisely because you don't know things such as the cash terms.

My default is to talk "real" whilst the majority of the audience, at least here, won't think and talk in that way.

Lootman
The full Lemon
Posts: 18681
Joined: November 4th, 2016, 3:58 pm
Has thanked: 628 times
Been thanked: 6564 times

Re: Inflation Linked Bonds: Passive or near-passive

#331779

Postby Lootman » August 8th, 2020, 6:26 pm

dealtn wrote:It is convention to quote all the new style index linked bonds in real, that is non-inflation adjusted prices. One of the main reasons is precisely because you don't know things such as the cash terms.

My default is to talk "real" whilst the majority of the audience, at least here, won't think and talk in that way.

Makes sense. With linkers you know in advance the real return but not the cash return. With conventional bonds you know the cash return but not the real return.

JohnW
Lemon Slice
Posts: 506
Joined: June 1st, 2019, 7:00 am
Has thanked: 5 times
Been thanked: 176 times

Re: Inflation Linked Bonds: Passive or near-passive

#331782

Postby JohnW » August 8th, 2020, 6:36 pm

dealtn wrote:So if my concern was that inflation might lead to prices doubling in say 10 years, I would be looking at what that would mean for my purchasing power, but also what are the entry and exit prices for my assets under such a scenario? ....A commodity fund might be priced at 100 and increase to 180, and selling would give you 90 pounds of equivalent to today spending power.

MIGHT is important there. How good is the link between inflation and a commodity fund price? Probably not as good as the change in the adjusted face value of a linker (and its coupons) are matched to inflation.

dealtn
Lemon Half
Posts: 6072
Joined: November 21st, 2016, 4:26 pm
Has thanked: 441 times
Been thanked: 2324 times

Re: Inflation Linked Bonds: Passive or near-passive

#331798

Postby dealtn » August 8th, 2020, 7:59 pm

JohnW wrote:
dealtn wrote:So if my concern was that inflation might lead to prices doubling in say 10 years, I would be looking at what that would mean for my purchasing power, but also what are the entry and exit prices for my assets under such a scenario? ....A commodity fund might be priced at 100 and increase to 180, and selling would give you 90 pounds of equivalent to today spending power.

MIGHT is important there. How good is the link between inflation and a commodity fund price? Probably not as good as the change in the adjusted face value of a linker (and its coupons) are matched to inflation.


The point is with a linker it is known, but that might 50%, with an alternative it is unknown but might (but only knowable afterwards) be more, and possibly >100%. With people looking for inflation protection, but generally meaning preserving purchasing power, linkers aren't sufficient in doing that, so alternatives are considered. Those alternatives don't give certainity but may be better. You just don't know advance.


Return to “Passive Investing”

Who is online

Users browsing this forum: No registered users and 12 guests