Learning about Gilts

[TheMotorcycleBoy]

Read a quote somewhere (haven't a link and can't be bothered to search), that suggested the average investors average stocks rewards lagged T-Bills. By the time you factor in brokers fees, market makers spread, fund manager fees, withholdings taxes and dividend/capital gains taxes ... alongside the tendency towards bad behaviour (sell-low (fear)/buy-high (greed)), many investors would have been better just having held T-Bills (short term bonds).....

Thanks this is all very interesting. Yet more food for thought.

Well, I purchased another "Fixed income securities" book the other day. I'd previously found Mark Gs book a very good intro, but I wanted to know more. Unfortunately I got slightly more than I bargained for in the form of:

https://www.amazon.co.uk/Fixed-Income-S ... 0470852771

Whilst I can handle some of the maths, to me this book is more a "sit down at a desk with pen+paper" book, rather than a read in the armchair book. Which is fine in it's place, and fortunately I bought it 2nd-hand, and may resell once I've had my fill of it.

I really wanted the book to clarify more of the terminology I've recently been reading, along with some slight elaboration of some the terminology I'd already understood.

For example, people speak of bonds/gilts being liquid or illiquid. I'm curious as to how this term exactly applies to those two asset classes. For instance I'd always assumed that liquidity just meant "cash-richness". So surely by that naive simplistic view bonds and gilts are always liquid, since if you require cash you sell them at the brokers. So does the terminology of liquidity mean that "how easy it is to exchange back for cash, at your desired price, i.e. to at least get back what you put in? IOW does this term's usage overlap onto that of risk?

Other terms I'd like to understand is more specifics such as "bullet bonds", "barbell", etc. Let's see what I can google!

Matt

[Alaric]

So does the terminology of liquidity mean that "how easy it is to exchange back for cash, at your desired price, i.e. to at least get back what you put in?

It's nothing to do with whether you make a loss or gain, but is to do with how easy it is to sell.

In Government Securities (Gilts) it would be rare that there wasn't both a willing buyer and willing seller. So the spread between buying and selling prices will be minimal. On less liquid issues whilst you might expect the yield to maturity to be that of the equivalent Gilt plus a risk factor, you may not find a buyer at that price. In other words whilst you think the price should be 130, the best anyone will offer is 125. In some cases, if at all.

Be careful with terminology as to whether you are reading an American book or an English one.

[johnhemming]

Liquidity for investments is an important issue that won't affect you unless you are aiming to buy or sell large quantities. Listed securities don't have a "price" so much as there being various prices that people are willing to sell shares (when I say shares I include all listed securities) to you or buy shares from you. The market that people normally use is called the "secondary market" because it is people (and organisations) buying and selling shares to each other. The primary market is where companies or the government issue shares to people. Generally you will not get involved in this.

For the listed securities market there is an important type of organisation when it comes to buying and selling shares. These are called "Market Makers" many years ago they were called "jobbers". They will give a price at which they will buy or sell a limited number of shares. They will mainly do this electronically and on the electronic systems you may get a slightly better price than the official price.

You can see the number of transactions and the price at which the deals were done in a number of ways. I use an online service called ADVFN, but they charge something for the service. The stock exchange offer a public service an example of which is here:

http://www.londonstockexchange.com/exch ... 8GBGBXSET1

If you look at various investments you will see that some have lots of people buying and selling large amounts of shares and some have relatively few transactions. The former are the liquid investments where if you want to buy or sell a large amount by value then you are likely to be able to do that at something like the quoted price. Those with fewer transactions are ones where if you want to buy or sell a lot you are likely to have to pay more or get less than the published offer or bid price. They have lower liquidity.

Generally the higher capitalised issues have larger numbers of transactions, but that isn't always true. You can tell by looking at the trading volumes.

Normal retail transactions, however, tend not to be affected by liquidity.

[TheMotorcycleBoy]

Thanks.

I think I'm starting to understand. The market makers effectively set the prices of assets. If they reduce (their) buy price/raise (their) sell price it means that although you can convert the asset to cash, it's difficult to, without doing so at a loss. And if you have a lot of their assets, then to you, they have lost their liquidity.

[TheMotorcycleBoy]

I looked at some gilt prices around Brexit to see how their responded. I kind of guessed that you'd purchase them say 10 months or so prior the event itself, and then had a good enough crystal to figure out when to resell them afterward.

I also tried to figure out some kind of buy/sell profit then included a year's worth of coupon.

(And out of curiousity I listed their price as of today)

1. 3 year maturity
==================
TS19 UNITED KINGDOM 1 3/4% TREASURY GILT 2019 
http://www.londonstockexchange.com/exch ... PUKGT.html

average buy in 2016: 103.5
23/6/2016 103.3
25/8/2016 104.5
Now 101.2

Assume own for a year prior to event, then sell soon afterward:
Profit (104.5-103.3)/103.3 = 1.16% + coupon 1.75% 
=2.91%


2. 5 year maturity
==================

TG21 UNITED KINGDOM 1 1/2% TREASURY GILT 2021
http://www.londonstockexchange.com/exch ... ml?lang=en

average buy in 2016 102.75
23/6/2016 102.75
12/8/2016 105.75
Now 101.5

Assume own for a year prior to event, then sell soon afterward:
Profit (105.75-102.75)/102.75 = 2.92% + coupon 1.5% 
=4.42%


3. 8 year maturity
==================
T24 UNITED KINGDOM 2 3/4% TREASURY GILT 2024
http://www.londonstockexchange.com/exch ... ml?lang=en

average buy prior in 2016: 110.5
23/6/2016 111.34
26/8/2016 118.15
Now 109.3

Assume own for a year prior to event, then sell soon afterward:
Profit (118.15-110.5)/110.5 = 6.79% + coupon 2.75%
=9.54%


4. 10 year maturity
==================
TG26 UNITED KINGDOM 1 1/2% TREASURY GILT 2026
http://www.londonstockexchange.com/exch ... PUKGT.html

average buy prior in 2016: 99
23/6/2016 99.95
26/8/2016 108.23
Now       101.3 (with yield of 1.39)

Assume own for a year prior to event, then sell soon afterward:
Profit (108.23-99)/99 = 9.32% + coupon 1.5%
=10.82%


5. 20 year maturity
==================
T4Q UNITED KINGDOM 4 1/4% TREASURY STK 36
http://www.londonstockexchange.com/exch ... ml?lang=en

average buy prior in 2016 133
23/6/2016 134.72
30/8/2016 154.9
now 138.34

Assume own for a year prior to event, then sell soon afterward:
(154.9-133)/133 = 16.47 %+ coupon 4.25
=20.72

So anyway at least that gave me a rough idea as how different bond maturities were affected by these kinds of events. Sorry if my figures/logic are misguided, comments+criticism are welcomed.

Matt

[johnhemming]

The market makers effectively set the prices of assets.

Everyone sets the prices. Not just the Market Makers. If lots and lots of people want to buy something the price will go up and vice versa. The market Makers set their prices (which are the bid and offer you see on real time prices) based upon who is buying and who is selling.

Normally more than one market maker makes a market in a share and they may have different bid and offer prices. It is also possible to do direct trades between seller and purchaser (agency cross) without involving a market maker.

Much that superficially the Market Makers appear to set the prices actually everyone "The Market" does.

A Market Maker will not just buy shares at a given price whilst they are not selling any at that prices and vice versa.

There are ways of getting at more information about who is willing to buy/sell what at what price and there is also the level 2 order book for some stocks. I get my level 2 from ADVFN. I don't know who else offers this at a good price.

Level 2 is an order book where you can put up an order (buy or sell) at a given price and someone else can electronically agree the trade with you. It might be interesting to watch that for a while (say 15 mins) with also watching the trade reporting in a given security. I don't think that this applies for gilts, however.

I put my Level 2 orders on via my broker, but anyone can watch it.

[GoSeigen]

So anyway at least that gave me a rough idea as how different bond maturities were affected by these kinds of events. Sorry if my figures/logic are misguided, comments+criticism are welcomed.

Matt

Looks good. Note that the movement in yield in each case was around 1% (the entire yield curve shifted down 1%). Then the gain for the investor was 1% multiplied by the modified duration in each case. Very roughly speaking.


GS

[TheMotorcycleBoy]

Note that the movement in yield in each case was around 1% (the entire yield curve shifted down 1%). Then the gain for the investor was 1% multiplied by the modified duration in each case. Very roughly speaking.


GS

Interesting. So this is the famous positive yield curve which Mark G's book briefly mentioned.

[Alaric]

So this is the famous positive yield curve which Mark G's book briefly mentioned.

Yield curve is usually a plot of the yield to maturity against the outstanding term of the bond. When it's "positive", bonds due to mature in the near future have a lower yield than ones with years or decades to run.

[GoSeigen]

Note that the movement in yield in each case was around 1% (the entire yield curve shifted down 1%). Then the gain for the investor was 1% multiplied by the modified duration in each case. Very roughly speaking.


GS

Interesting. So this is the famous positive yield curve which Mark G's book briefly mentioned.

There were two aspects to what I wrote: first, I noted that each maturity of gilts experienced a fall in yield which I estimated at around 1%, so the whole curve shifted down by 1%; second, I referred to a well-known rule of thumb for bonds, where a movement in the bond's price is equal to the movement in its yield multiplied by its duration; hence the clear pattern in the one-year returns you had calculated.


I don't know about Glowrey's reference to a "positive yield curve". If I read these words I'd assume it referred to the positive slope normally found on the yield curve -- which is not directly relevant to my earlier post. But if I've misunderstood, please quote the relevant section from Glowrey.


GS

[TheMotorcycleBoy]

Fundamentally gilts are priced to inflation expectations. Nominal gilt yield for a fixed date less the inflation gilt yield of the same/similar date is suggestive of what the market expects inflation to be between now and that date.

Thanks for this. But can you clarify what you meant when you differentiate between nominal gilt yield and inflation gilt yield please? For example if you refer to TG26 here:

http://www.hl.co.uk/shares/shares-searc ... -2026-gilt

you can see the term "Redemption yield" (which seems to be almost the same as YTM). So how does that compare with your two terms that I referred to above?

Characteristics of shorter dated having more price stability/yield volatility, longer dated having more yield stability/price volatility. Conceptually both tend to broadly compare equally in total return, but in very broad terms. A barbell of 1 year and 20 year gilts held to equal value tends to compare to a central 10 year bullet. Rebalancing a barbell back to 50/50 keeps that so, but doesn't broadly add anything (no real rebalance benefit). Where real benefit can be achieved is by appropriate/lucky timing.

I'm now clear on what a bullet bond and a barbell mean. For us, since we are investing small amounts (probably 2-3k in gilts this year, after more research) I think it's best if we minimise our trade fees (no periodic rebalancing), so I think that the bullet bond is best for us.

Generally the way to go is to be buying longer dated when inflation/yields are relatively high, or buying shorter dated when inflation/yields are relatively low.

I guess this is the crux of my problems right now, i.e. getting a feel for when you say inflation is high, and when you say long-dated do you mean 10-30 years maturity, and when you say low inflation and short-dated do you mean 1-5, or 1-10 years etc.

So currently our inflation rate is about 2.5% or thereabouts. Historically (I was born in 1968) that seems low, but when viewed over the last 10 years or so, I'd say that's a median really, since we peaked at 5% or so back in Sep 2008 and May 2011, and have since generally hoover around 0-3%.

So what kind of bond maturity should we be buying when inflation is about 2 to 3%? In your opinion that is - I accept it's not financial advice!

Broadly discount those bonds that do default and the higher yield/reward premium is negated/lost. If you're opening yourself up to default risk then the general advice is to take risk on the stock front, not on bonds.

We have invested some in corporate bonds already, alas they are reasonably risky, but we did some research prior on the borrower, so fingers crossed. They are IPF1 with 25 months left, and had YTM of about 5.75% when we purchased them.

thanks again for your help
Matt