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Should I sell gilts?

Gilts, bonds, and interest-bearing shares
martininvestor
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Should I sell gilts?

#514756

Postby martininvestor » July 16th, 2022, 9:45 am

I am the process of moving my investments away from a financial adviser so we can manage them more actively ourselves. The adviser's investment strategy included very high exposure to UK gilts, some 20% of our assets were invested in the Allianz Gilt Yield fund which, along with other gilt funds has performed poorly over over the last year, currently at minus 14%. I can find little to no commentary on the outlook for gilts and whether this is a good time to sell or hold. With rising inflation, the outlook seems poor until inflation starts falling. As we are in our 60s we are constrained regarding long-term investing. What does the forum think about the outlook for UK gilts?

Alaric
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Re: Should I sell gilts?

#514770

Postby Alaric » July 16th, 2022, 11:18 am

martininvestor wrote: What does the forum think about the outlook for UK gilts?


Speculation might be that the Bank of Emgland will continue to raise interest rates as a measure to attempt to bring retail price increases under control. This will make borrowing, including Government borrowing more expensive and depress prices on the secondary market. In other words existing holders of Gilts and other Fixed Interest are likely to see price falls. Going forward, new investors may expect to see higher returns as coupon rates are increased for new issues.

martininvestor
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Re: Should I sell gilts?

#514775

Postby martininvestor » July 16th, 2022, 11:44 am

Very helpful Alaric thank you, makes complete sense

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Re: Should I sell gilts?

#514783

Postby GeoffF100 » July 16th, 2022, 12:44 pm

I bought some index linked gilts on a real redemption yield of -0.1%, i.e. I would lose slightly at redemption after inflation is taken into account, but not by much. I sold some when the real redemption yield was at about -3%. I am tempted to buy them back at a real redemption yield of about -0.7%. The price could fall if short term interest rates rise more than the market expects, but I will be protected at redemption if inflation proves hard to shift.

GeoffF100
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Re: Should I sell gilts?

#514802

Postby GeoffF100 » July 16th, 2022, 1:57 pm

I have looked at my stock on Tradeweb. The real redemption yield is about -1.67%, which is not so tempting. The price has risen a little recently. The price of global bonds hedged into sterling has also risen recently:

https://markets.ft.com/data/etfs/tearsh ... GP:LSE:GBP

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Re: Should I sell gilts?

#514958

Postby JohnW » July 17th, 2022, 1:24 am

martininvestor wrote: As we are in our 60s

You might still have 20 years investing ahead of you, so don't overlook the long term view.
What does the forum think about the outlook for UK gilts?

Now you're moving away from investing into speculating. Is that really what you want to do in your 60's? Or is it not speculating?
Speculation might be that the Bank of Emgland will continue ....

Yes, that's speculating.
For investing, you want a sensible plan that takes account of your circumstances and what might happen because it's all happened before. Probably better not to keep messing with it on the basis of speculation; even the professionals can't pull that off reliably. The best chance a good investment strategy has of delivering its potential is by sticking to it.
Good luck.

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Re: Should I sell gilts?

#515050

Postby dealtn » July 17th, 2022, 2:47 pm

Alaric wrote:
martininvestor wrote: What does the forum think about the outlook for UK gilts?


Speculation might be that the Bank of Emgland will continue to raise interest rates as a measure to attempt to bring retail price increases under control. This will make borrowing, including Government borrowing more expensive and depress prices on the secondary market. In other words existing holders of Gilts and other Fixed Interest are likely to see price falls. Going forward, new investors may expect to see higher returns as coupon rates are increased for new issues.


Have to say I disagree with that logic.

Gilt returns will reflect the change in the expected path of interest rates from the current expected path. That current path already reflects a number of interest rate rises. Interest rate rises in themselves don't determine Gilt prices (and investment returns).

We could see continuing rate rises over the next 5 years and Gilts provide positive returns and rising prices (and lower than currently expected Coupons too).

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Re: Should I sell gilts?

#515090

Postby Alaric » July 17th, 2022, 6:23 pm

dealtn wrote:Interest rate rises in themselves don't determine Gilt prices (and investment returns).
.


Could you explian your logic please? Taking short term Gilt rates for non-indexed Bonds, that's under five years, why wouldn't the coupon required for new issues be set with some reference to the rates set by the Bankof England as part of its monetary policy? If you can buy a new issue for five years with a coupon of 2%, why wouldn't an existing issue with a coupon of 1% and five years to run stand at a discount?

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Re: Should I sell gilts?

#515092

Postby tjh290633 » July 17th, 2022, 6:34 pm

Alaric wrote:
martininvestor wrote: What does the forum think about the outlook for UK gilts?


Speculation might be that the Bank of Emgland will continue to raise interest rates as a measure to attempt to bring retail price increases under control. This will make borrowing, including Government borrowing more expensive and depress prices on the secondary market. In other words existing holders of Gilts and other Fixed Interest are likely to see price falls. Going forward, new investors may expect to see higher returns as coupon rates are increased for new issues.

Attempts to control inflation are one reason to raise interest rates, but another effect is to strengthen the GBP, which will reduce the price to us if buying commodities and fuel prices in USD. The spineless lack of action by the MPC is a direct contributor to inflation.

There ought to be commensurate increases in interest rates on bank deposits, which will benefit rich and poor savers alike. Investors in fixed interest securities will lose capital value but keep the income at its fixed rate. But they knew that would happen if they bought above the redemption value.

TJH

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Re: Should I sell gilts?

#515101

Postby Bubblesofearth » July 17th, 2022, 7:03 pm

martininvestor wrote: What does the forum think about the outlook for UK gilts?


If you are buying gilts to hold until redemption then your return is known and you can decide whether that is acceptable or not.

If you are buying gilts to trade then the expected return is still the known return mentioned above. You may get more or you may get less depending on capital movements but the expected return is still the best guide for determining whether they are worth investing in or not.

BoE

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Re: Should I sell gilts?

#515560

Postby dealtn » July 19th, 2022, 9:41 am

Alaric wrote:
dealtn wrote:Interest rate rises in themselves don't determine Gilt prices (and investment returns).
.


Could you explian your logic please? Taking short term Gilt rates for non-indexed Bonds, that's under five years, why wouldn't the coupon required for new issues be set with some reference to the rates set by the Bankof England as part of its monetary policy? If you can buy a new issue for five years with a coupon of 2%, why wouldn't an existing issue with a coupon of 1% and five years to run stand at a discount?


Issue price is generally set close to par (and redemption at par), with Coupons close to market rates - being the other side of the same coin. Obviously negative market rates can have an influence on this, as negative coupons are problematic, and investors deemed "need" to have some coupon income. So 0.125% is in practice the minimum. You can see this distortion much more readily in the index linked market than conventionals.

However, consider a Gilt curve where short term rates (ie close to BoE current policy rate) are 1%, but are expected by the market to rise by 1% every year over the next 5 years, so crudely average 3% over the life. Market price is about 100 for a 3% Coupon.

Now consider over the 5 year life of that BoE interest rates do rise. However they rise by 2% each year, not 1%. What do you think the path of that Gilts price would look like over the 5 years? Consider an alternative where they rise but on average just 0.5% each year. What does that path look like? How different is it to the first scenario?

Interest rate rises in themselves don't determine Gilt prices, and investment returns. It is the change in market interest rates relative to the original expected rate rises that do.

The only known return (and that's assuming no issuer default, nor the effects of inflation) are at the outset. In that case it is irrelevant even what interest rates do in the meantime or life of a Gilt investment, if you are holding to maturity.

Your original statement that "(Speculation might be that) Bank of England continue to raise interest rates ... and depress prices on the secondary market ..." doesn't follow I'm afraid. That might happen, but there are many scenarios where the Bank does continue to raise rates, but crucially below current expectations for those changes in policy rate, and secondary market prices rise, or indeed strongly rally.

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Re: Should I sell gilts?

#515575

Postby Alaric » July 19th, 2022, 10:31 am

dealtn wrote:
Your original statement that "(Speculation might be that) Bank of England continue to raise interest rates ... and depress prices on the secondary market ..." doesn't follow I'm afraid. That might happen, but there are many scenarios where the Bank does continue to raise rates, but crucially below current expectations for those changes in policy rate, and secondary market prices rise, or indeed strongly rally.



I think you are trying to deny the mathematics of bond prices, assuming you believe the expectations theory applies to conventional bonds.

Price a bond at a 1% redemption yield, you get a price. Whether it's above or below par will depend on whether the coupon exceeds 1%. Now price the same bond at a 2% reemption yield. Why do you not expect the price to fall?

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Re: Should I sell gilts?

#515597

Postby GoSeigen » July 19th, 2022, 11:34 am

Alaric wrote:
dealtn wrote:
Your original statement that "(Speculation might be that) Bank of England continue to raise interest rates ... and depress prices on the secondary market ..." doesn't follow I'm afraid. That might happen, but there are many scenarios where the Bank does continue to raise rates, but crucially below current expectations for those changes in policy rate, and secondary market prices rise, or indeed strongly rally.



I think you are trying to deny the mathematics of bond prices, assuming you believe the expectations theory applies to conventional bonds.

Price a bond at a 1% redemption yield, you get a price. Whether it's above or below par will depend on whether the coupon exceeds 1%. Now price the same bond at a 2% reemption yield. Why do you not expect the price to fall?


Now Alaric is talking about yields and not interest rates. dealtn's post dealt with his earlier question about (BoE) monetary interest rates.

Let's try to keep two things simultaneously in our heads. Or alternatively stick to the subject of the discussion!


GS

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Re: Should I sell gilts?

#515604

Postby scrumpyjack » July 19th, 2022, 11:44 am

"Should I sell gilts"

Reminds me of the reply I got in Ireland when I was hitching my way round 50 years ago. I asked a farmer the way to xxxx. He replied that if he wanted to get to xxxx, he wouldn't start here!

I wouldn't hold gilts in the first place :D

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Re: Should I sell gilts?

#515839

Postby dealtn » July 20th, 2022, 7:22 am

Alaric wrote:
dealtn wrote:
Your original statement that "(Speculation might be that) Bank of England continue to raise interest rates ... and depress prices on the secondary market ..." doesn't follow I'm afraid. That might happen, but there are many scenarios where the Bank does continue to raise rates, but crucially below current expectations for those changes in policy rate, and secondary market prices rise, or indeed strongly rally.



I think you are trying to deny the mathematics of bond prices, assuming you believe the expectations theory applies to conventional bonds.

Price a bond at a 1% redemption yield, you get a price. Whether it's above or below par will depend on whether the coupon exceeds 1%. Now price the same bond at a 2% reemption yield. Why do you not expect the price to fall?


Neither you or I price those bonds. They are priced by the market by the against the predicted expected path of interest rates. Neither bond will move in price until or unless the predicted path of interest rates changes. If the future path of interest rates is upwards, as currently predicted and priced by the market, and interest rates do rise over the remaining life, then those prices might go either up or down. It is not the direction that matters, it is the second order that determines price movements, that being the relative change to the originally expected path.

Failure to understand that is a simple demonstration of an inability to grasp bond mathematics.

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Re: Should I sell gilts?

#515865

Postby Alaric » July 20th, 2022, 8:45 am

dealtn wrote:Failure to understand that is a simple demonstration of an inability to grasp bond mathematics.


The price of a bond is determined by discounting its cash flows at the redemption yield. Are you saying that if the Bank of England were to announce, say, a change in its base rate from1% to 2%, this wouldn't have an effect on the prices of short bonds, up to five years, at the very least?

If you want a more sophisticated method, each individual cash flow of the bond an be discounted at the zero coupon rate for its particular duration. It still says that a change in the zero coupon rate changes the bond price. That's for conventional bonds where the cash flows are known. For indexed bonds, the rules are known but not the future values of the linked index.

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Re: Should I sell gilts?

#515889

Postby BT63 » July 20th, 2022, 9:20 am

Alaric wrote:The price of a bond is determined by discounting its cash flows at the redemption yield. Are you saying that if the Bank of England were to announce, say, a change in its base rate from1% to 2%, this wouldn't have an effect on the prices of short bonds, up to five years, at the very least?


BoE have signalled that a 50bp hike is quite possible at the next meeting so short-dated bonds might already have 'priced in' that increase, therefore little or no reaction in price or yield on the day of the rate hike.
If BoE only raise 25bp but the market was expecting 50bp, the price of short dated bonds might even rise (and yields fall).
Or, one day, the market might react with horror at the BoE's lethargy in dealing with inflation, and dump UK bonds, with prices and yields bearing no resemblance to actual rates because markets have lost confidence.

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Re: Should I sell gilts?

#515910

Postby GoSeigen » July 20th, 2022, 10:12 am

Alaric wrote:
dealtn wrote:Failure to understand that is a simple demonstration of an inability to grasp bond mathematics.


The price of a bond is determined by discounting its cash flows at the redemption yield. Are you saying that if the Bank of England were to announce, say, a change in its base rate from1% to 2%, this wouldn't have an effect on the prices of short bonds, up to five years, at the very least?


Why do you ask this sort of thing? It is really simple to just get the data and plot interest rate announcements against subsequent change in gilt yields in a scatter plot and produce a regression.

Please post the results when you have done it.

It would be nice if you could do the same exercise using rate announcements vs gilt yield change in period previous to the announcement, as it is my opinion that until recent times it it the market that has pushed the BoE and not the other way round.

Tapping fingers... but not holding my breath :-/


GS

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Re: Should I sell gilts?

#515998

Postby Alaric » July 20th, 2022, 1:44 pm

GoSeigen wrote:
Why do you ask this sort of thing?


I'm accused of not understanding the mechanics of bond pricing. But why is not fundamental that the higher the interest rate, the lower the bond proce?

Bond valuation is A level mathematics using geometric progressions.

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Re: Should I sell gilts?

#516098

Postby dealtn » July 20th, 2022, 9:59 pm

Alaric wrote:
GoSeigen wrote:
Why do you ask this sort of thing?


I'm accused of not understanding the mechanics of bond pricing. But why is not fundamental that the higher the interest rate, the lower the bond proce?

Bond valuation is A level mathematics using geometric progressions.


The higher the rate of interest the lower the bond price. Correct.

But that isn't what you are arguing. You made the statement that if policy rate (which is also the closest proxy to the very short term Gilt rate) were to rise then Gilt prices would fall. That is (seriously) wrong as I have tried to politely explain a number of times. Bond prices are determined either by discounting the respective cashflows by the respective discount rates for that cashflow date, or collectively by a single redemption yield discount for all cashflows, which is the same thing as a boot strapped gilt redemption yield curve.

Firstly you need to recognise that a change in the policy rate will affect different parts of the gilt curve in different ways, and secondly that over time it is the path of all the aggregated short term rates that make a term curve, and that as time progresses it is the difference between the path of the actual policy rate(s) and their previously market predicted future rates that will decide whether Gilt prices rise or fall from that original market price. The direction of the interest rate change is not the reason prices change.

If a market is in equilibrium with a (short dated) Gilt price at 100 and an exactly predicted rise (or fall) occurs, the Gilt prices won't fall (or rise). They will go nowhere.

Were a prediction be for a 50bps rise and only 25bps occurred, rather than a fall in price, the market likely rallies, and the opposite for a 100bps rise. The same, but reversed for cuts.

So unlike your original claim that continued rises in policy rate being bad for gilt prices it REALLY isn't true, and doesn't follow from Bond maths. It only matters how that rise happens relative to the path predicted by current spot gilt yields. There are many potential paths of interest rates from here that are solely made up of interest rate rises that lead to positive Gilt market returns, and in some that could be spectacular rallies.


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