Question
How do I work out whether now is a good time to buy Index linked gilts, either direct or via an ETF? Are they expensively rated at the moment? If inflation moves higher, how will this affect the price? And vice versa.Answer
Whether or not index-linked gilts are worth buying depends almost entirely on where you think future inflation is headed.
When you buy an index-linked gilt both income and the redemption price are linked to inflation (measured by the Retail Price Index - RPI), so it has a potentially significant impact on investment returns.
I find the best way to gauge the attractiveness of index-linked gilts is to look at the break-even inflation rate - that is the rate of inflation where returns from the index-linked gilt held to redemption equal those of a comparable conventional gilt.
If you think the average inflation rate will be higher than the break-even rate between now and maturity then index-linked gilts would look worthwhile, otherwise conventional gilts would appear better value.
You can find break-even inflation rates in the FT - let's look at a couple of examples:
The 2.5% index-linked gilt redeeming in July 2016 has a break even inflation rate of 2.30% (based on its 5 October price) while the same figure for a 2% index-linked gilt redeeming in January 2035 is 3.25%.
Annual RPI is currently 4.7%, well above these break-even rates. But will it remain high? Over the next year or two I'm not convinced, I think the combination of higher taxes and spending cuts will drag down inflation, possibly even into negative territory (called 'deflation'), which is an index-linked gilt's worst nightmare (because both income and the redemption price will fall).
If you buy an index-linked gilt now and inflation is lower than expected you could lose money (the gilt's price will fall to reflect the downward affect on income and the redemption price) and, of course, vice-versa.
The outlook for inflation is currently very uncertain and even if inflation falls shorter term it could rise longer term, so the decision on whether to buy index-linked gilts now is a difficult one. Unless you're convinced inflation will remain high, I'd be tempted to hold-fire for the time being.
How do I work out whether now is a good time to buy Index linked gilts, either direct or via an ETF? Are they expensively rated at the moment? If inflation moves higher, how will this affect the price? And vice versa.Answer
Whether or not index-linked gilts are worth buying depends almost entirely on where you think future inflation is headed.
When you buy an index-linked gilt both income and the redemption price are linked to inflation (measured by the Retail Price Index - RPI), so it has a potentially significant impact on investment returns.
I find the best way to gauge the attractiveness of index-linked gilts is to look at the break-even inflation rate - that is the rate of inflation where returns from the index-linked gilt held to redemption equal those of a comparable conventional gilt.
If you think the average inflation rate will be higher than the break-even rate between now and maturity then index-linked gilts would look worthwhile, otherwise conventional gilts would appear better value.
You can find break-even inflation rates in the FT - let's look at a couple of examples:
The 2.5% index-linked gilt redeeming in July 2016 has a break even inflation rate of 2.30% (based on its 5 October price) while the same figure for a 2% index-linked gilt redeeming in January 2035 is 3.25%.
Annual RPI is currently 4.7%, well above these break-even rates. But will it remain high? Over the next year or two I'm not convinced, I think the combination of higher taxes and spending cuts will drag down inflation, possibly even into negative territory (called 'deflation'), which is an index-linked gilt's worst nightmare (because both income and the redemption price will fall).
If you buy an index-linked gilt now and inflation is lower than expected you could lose money (the gilt's price will fall to reflect the downward affect on income and the redemption price) and, of course, vice-versa.
The outlook for inflation is currently very uncertain and even if inflation falls shorter term it could rise longer term, so the decision on whether to buy index-linked gilts now is a difficult one. Unless you're convinced inflation will remain high, I'd be tempted to hold-fire for the time being.
Read this Q and A at http://www.candidmoney.com/questions/question294.aspx
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