Inflation linked gilt funds

[MarathonInvestor]

Hi

Could anyone tell me why inflation linked gilt funds never pay a dividend even when an income share class is available? My understanding is that index linked gilts pay a coupon twice a year in the same way that fixed income gilts do. However, i have looked at several index linked gilt funds (Vanguard, L&G) and although they offer income share classes, those share classes never pay a dividend. Why is that?

[Alaric]

However, i have looked at several index linked gilt funds (Vanguard, L&G) and although they offer income share classes, those share classes never pay a dividend. Why is that?

One guess is that the income is so small, it all goes in charges.

[MarathonInvestor]

Yeah, I was wondering that too. However, the income would be similar to that from regular gilts and those funds do pay dividends. Interestingly, the absolute returns from inflation linked gilts look to be far ahead of those from regular gilt funds. There looks to be a convention for index linked gilt funds to always reinvest distributions whatever the share class type.

[Alaric]

However, the income would be similar to that from regular gilts and those funds do pay dividends.

Many index Gilts offer interest as near to zero as possible. 1/8% for example.

[MarathonInvestor]

True, but inflation is added to that. So a 1/8% gilt would have offered a coupon with something like 1.8% return. Perhaps that is still too low to bother paying.

[TedSwippet]

True, but inflation is added to that. So a 1/8% gilt would have offered a coupon with something like 1.8% return. Perhaps that is still too low to bother paying.

The inflation uplift part usually turns up as capital gain, not as coupon.

[MarathonInvestor]

Ah, interesting. I thought it turned up on both. Perhaps I've been reading the wrong websites.

[mc2fool]

True, but inflation is added to that. So a 1/8% gilt would have offered a coupon with something like 1.8% return. Perhaps that is still too low to bother paying.

The inflation uplift part usually turns up as capital gain, not as coupon.

Not so.

"Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal payment are adjusted in line with movements in the General Index of Retail Prices in the UK (also known as the RPI)." https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

[Alaric]

"[i]Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal payment are adjusted in line with movements in the General Index of Retail Prices in the UK

What that means is that if the coupon starts off at 0.1%, then it is £ 100 per £ 100,000 nominal holding. If RPI is 3%, the coupon increases to £ 103.

Back in the day when the UK Government paid half decent returns on the money it borrowed, you might perhaps have got £ 3,000 per £ 100,000 nominal. £ 3,000 increasing at 3% at year is a lot more than £ 100 doing the same.

[dealtn]

True, but inflation is added to that. So a 1/8% gilt would have offered a coupon with something like 1.8% return. Perhaps that is still too low to bother paying.

Inflation and coupon payments don't work like that.

If you start with £100 bond (that you might pay £200 for!) that pays 1/8% you get 12.5p coupon (not quite as it pays semi-annually) per £100, and this goes up by RPI.

I have no idea on fund charges, but presumably they are on a % of capital.

To make the maths simple say you invest £100,000 to buy £100,000 (nice if you can find a way of doing this!) of bond and RPI is 3% each year. After a year you have income of £128.75 and a bond worth £103,000 (assuming no change in price etc.) If you pay 1% fees on the fund this is £1,030 in fees. Not difficult to see why such a fund would feel reasonable in not paying you any income, and presumably deducting fees from capital.

Repeat for each year.

No idea if that's how such funds work as I wouldn't ever invest in one.

[MarathonInvestor]

OK, this is the reply I got from Vanguard when I asked:

"Because the income is not currently outweighing inflation, income is re-invested into the fund to help it track inflation. If, or when, income outweighs inflation the fund will pay out distributions accordingly."

I think that makes sense and it seems to be true for all index linked gilt funds I've looked at. They only pay a divide when the price of the fund is increasing quicker than inflation. At the moment such funds are unlikely to pay a dividend as the value of the fund is falling as most people think inflation will fall because of the falling price of oil.

Incidentally, the charges for these types of funds tend to be around 0.1%