Showing posts with label gilts. Show all posts
Showing posts with label gilts. Show all posts

Thursday 26 March 2009

Gilts: what are they?

Gilts: what are they?
A guide to Government gilts.

Last Updated: 12:26PM GMT 26 Mar 2009

What is a gilt?

Gilts are bonds issued by the Government to raise money. The term originated in Britain and referred to debt securities that had a gilt (or guilded) edge.

Who issues them?

Since April 1998 gilts have been issued by the Debt Management Office on behalf of HM Treasury.

Is their more than one type of gilt?

Yes. Conventional gilts are the simplest form of government bond and are the largest share of liabilities in the Government's portfolio. They guarantee to pay the holder a fixed cash payment - or coupon in bond jargon - every six months until the bond matures, at which point the holder receives the final coupon payment and get his original investment back. An investor who holds £1,000 nominal of 4pc Treasury Gilt 2016 will receive two coupon payments of £20 each on 7 March and 7 September until it expires in 2016.

There are other types such as index-linked gilts (IGs), which form the largest part of the gilt portfolio after conventional gilts. Here the coupon is related to movements in the Retail Prices Index (RPI) - in other words, it is linked to inflation.

How do you buy them?

Gilts can either be bought directly from the DMO at its outright gilt auctions or through the secondary market. Bidders at auction can choose to participate through a Gilt-edged Market Maker (GEMM) - a form of broker - who can bid directly by telephone to the DMO on the bidder’s behalf, or by completing an application form, providing that they are members of the DMO’s Approved Group of Investors.

Who buys them?

Anyone can buy gilts. Pension funds are by far the biggest buyers as they need to meet payments when people retire. They are also used by individuals who are looking for a steady income or as part of a balanced investment portfolio.

Source: DMO

http://www.telegraph.co.uk/finance/economics/5054206/Gilts-what-are-they.html

Thursday 12 March 2009

'Sell every asset except gilts'

'Sell every asset except gilts'
Conventional assets – even gold – are no good as hedges against the inevitable deflation, says one asset manager.

By David Kauders
Last Updated: 12:17PM GMT 11 Mar 2009

At the end of last week, gilt prices soared and yields fell again. The market reacted positively to the Bank of England's announcement of quantitative easing. Yet in the preceding days and weeks the market had been spooked by concerns that the bail-outs would create inflation. Why the sudden change in sentiment?

It has long been our view that inflation scares have been seriously overstated and the real risk is deflation. Deflation occurs when a shrinking economy leaves businesses and consumers who have already borrowed heavily earning less and therefore unable to afford their existing debts.

There is the danger of a downward spiral caused by less income to pay interest. This is what the authorities are trying to avoid.

In a deflationary environment, only fixed-coupon gilts prosper: even index-linked stocks are ineffective. This is because the real rate of interest (nominal interest less inflation) has historically been around 2pc to 3pc for centuries.

If prices are falling rather than rising, fixed-coupon gilts gain in value, whereas the indexation formula for index-linked gilts indexes downwards with no floor. Other asset classes such as shares, property and many commodities depend on the continued take-up of more credit – which is why they did so well for many years.

As the credit crunch proceeded, governments introduced more and more bail-outs to keep banks lending. Real money, which has to be raised by increased taxation or by selling new gilts, was spent. This gave rise to fears that excess supply would depress gilt prices. Yet events show that the fears were mistaken. There are a number of reasons for gilt prices rising as supply expands:

  • The biggest beneficiary of lower interest rates is government, as lower rates cut the cost of servicing the national debt;
  • Pension funds are willing buyers and therefore absorb any supply offered to them;
  • Risk elsewhere leads to a flight to quality and safety, irrespective of price.
  • In addition, the Treasury have been selling new gilts to the market through the Debt Management Office's auction programme in order to fund the Government's spending. This takes cash out of the economy, yet the Bank of England wants to buy gilts back to put public money into the economy.

If the policy works it may ameliorate the recession, but the result is that the Bank of England counteracts the effect of the Treasury's extra supply of gilts.

Being realistic, there are many reasons why this quantitative easing may be of only cosmetic effect: why should banks lend to over-indebted businesses and consumers? What if they just run down their derivatives positions further?

Banks and building societies have to hold capital in reserve to ensure they can meet any losses. Historically, they had significant holdings in gilts and deposits at the Bank of England, but over the past 30 years standards were relaxed and other types of debt security were brought into those reserves.

Now they are rediscovering the advantages of having highly saleable assets such as gilts in their core capital and are therefore willing buyers of government bonds. Such bank purchases are significant, just as pension funds will be material buyers when they opt for certainty instead of risk to stem their losses in stock markets.

These large investors are the only ones who can sell to the Bank of England, yet they have good reasons for being net buyers.

However you look at it, institutional demand is increasing no matter what the supply of gilts. Nearly 20 years ago, in the recession of the early 1990s, the Government sold more gilts and prices rose (yields fell), in that case from around 13pc in 1990 to around 9pc in 1993. Inflation then was around 10pc and about to fall sharply. Notice the parallels as inflation now threatens to turn into deflation, the Government issues more gilts and prices rise again.

Investors have been pursuing property and gold for protection against financial risk. But property is an inflation hedge, not a deflation hedge, since its price level depends on the continued supply of credit.

There are also demographic factors that have favoured property in the postwar years but now turn against it: the lower birth rate, extensive owner occupation and the shift from net immigration to net emigration. Add this to the current financial pressure, and you can see why property is no longer a viable investment.

As for gold, it is the ultimate inflation hedge, since easy money provides the fuel for more people to buy it. But it is not a deflation hedge, for one simple reason. No currency is exchangeable into gold and no government is going to wreck its country's economy by adopting a gold standard.

This explains why the gold price perks up occasionally then always slips back again. The safest asset in the financial system is the promise of government to honour its own debt.

Private investors need to go with the flow. Investing in stock markets, like property, is proving singularly unrewarding at present. We believe the bear markets have much further to run before shares and property are cheap enough to buy again.

Since income offered by gilts is still above that earned from many bank accounts and there is a continuing flight to quality, gilt prices must go on rising until this deflation is over.

Investors should change to a gilt-only strategy to preserve capital and income. This way, they will have the cash to buy the bargains when stock markets offer them.

David Kauders is a partner at Kauders Portfolio Management.

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http://www.telegraph.co.uk/finance/personalfinance/investing/4969399/Sell-every-asset-except-gilts.html