Redemption Yield

[tjh290633]

There has been a discussion on another forum about whether the DMO quoted figures for redemption yield are the same as total return to be expected. This arose because another poster pointed out that his ETF from Vanguard in I-L Gilts had risen considerably over the last few years, yet the DMO predict negative redemption yields for every I-L Gilt.

I appreciate that I-L Gilts make asumptions about the change in RPI/CPI until maturity, but is there any reason why the quoted redemption yield should not be the predicted total return for that gilt if held to maturity? Does it assume 20% interest tax is deducted, for example?

TJH

[Alaric]

This arose because another poster pointed out that his ETF from Vanguard in I-L Gilts had risen considerably over the last few years, yet the DMO predict negative redemption yields for every I-L Gilt.

Negative real redemption yields. In other words the maturity value will be greater in money terms, but it will buy less goods and services than the original purchase price would. Returns on an ETF are conventionally expressed purely in money terms.

The calculation method of the yield on an indexed stock is firstly to pick a rate of revaluation. You then project the payments under the stock and calculate the yield in the same way as for a conventional stock. You then subtract the rate of revaluation you thought of earlier.

If there was ever a return to the levels of inflation seen in the past, Indexed Gilts will become very expensive to service and governments can only hope that tax revenues would rise to make them affordable. If on the other hand, governments could stabilise prices, Indexed Gilts would seem like confiscation. You lend money to the Government, it pays you 1/8th of a percent in interest and gives the money back twenty years or more later.

[hiriskpaul]

There has been a discussion on another forum about whether the DMO quoted figures for redemption yield are the same as total return to be expected. This arose because another poster pointed out that his ETF from Vanguard in I-L Gilts had risen considerably over the last few years, yet the DMO predict negative redemption yields for every I-L Gilt.

I appreciate that I-L Gilts make asumptions about the change in RPI/CPI until maturity, but is there any reason why the quoted redemption yield should not be the predicted total return for that gilt if held to maturity? Does it assume 20% interest tax is deducted, for example?

TJH

To start with it must be clear what is meant by total return. If total return is taken to be the same as compound annual growth rate, then total return to maturity will be approximately the same as gross redemption yield if upon each coupon reinvestment, the GRY of the gilt remains unchanged. I say approximately because of the nuances of the definition of GRY and the fact that gilt coupons are paid semi-annually rather than annually. If it wasn't for the nuances and semi-annual payments, GRY would be identical to CAGR if every coupon was reinvested at constant GRY.

In reality though, the TR of an intermediate to long dated gilt is unlikely to be even approximately the same as GRY because gilt GRYs do not stay static throughout the lifetime of a gilt, so the return of each reinvested coupon will vary.

The TR of an intermediate or long dated gilt portfolio/ETF is more complicated than the TR of a held to maturity gilt as the gilts in the portfolio will typically not be held to maturity. Instead the ETF will tend to roll from shorter to longer dated gilts. So the return of the ETF will depend on capital gains/losses during the period each gilt is held as well as the returns on reinvestment of coupons. For a nomal upward sloping yield curve, a total return in excess of the initial GRY of a gilt can be expected if a gilt is sold before maturity. In addition, intermediate and long gilt yields have dropped substantially over the last 30 or so years and this drop has also boosted the returns seen by gilt portfolios and ETFs.


p.s. No, the DMO GRY quotations do not take into account any taxes.

[BarrenWuffett]

I think many investors look at the yields on gilts and are put off by the redemption yields which in recent years have been v low and even negative however like shares, gilts and other bonds are traded on the markets and their purchase price naturally fluctuates according to supply and demand just as a share price will fluctuate.

Obviously this will provide opportunities to make a return which can be higher than the yield so the return on bonds and gilts includes the coupon or interest payments + any gain on the purchase/sale of the investment - again just the same with shares, the return an investor enjoys is the dividend which will normally be a known factor at the time of purchase + the capital appreciation (or loss) when sold which is an unknown factor.

Many investors will have come across the Barclays Equity Gilt Study which compares the inflation-adjusted returns on equities, gilts, I/L gilts and cash over various periods - here's an article on Monevator from last year...http://monevator.com/uk-historical-asset-class-returns/

The chart shows that the annualised real returns for both gilts and I/L gilts were higher than equities over both 20 yr and 10 yr period to 2015. The investor who disregards gilts and bonds as part of the mix takes on more risk and volatility and may get a lower return.