UK unveils world's longest-dated inflation-linked bond
The UK's Debt Management Office (DMO) has launched what it believes to be the longest-dated sovereign inflation-linked bond in the world.
The gilt is linked to the Retail Prices Index (RPI), which means the capital value and coupon value will be uprated in line with inflation. The first coupon of this bond will be paid on 22 March 2012, with the coupon value set some months before that.
In just 30 minutes, investors had snapped up £3.5 billion worth of the gilts, and the offer closed early just an hour and a half after opening, with the sales of the gilt totalling £9.8 billion.
Amid ongoing market volatility and high inflation, UK investors bought up around 99% of the allocation.
The transaction was the fifth of the 2011-12 gilt offerings announced in the 2011 Budget, which planned to raise £31.6 billion.
So far, the government has raised £21.2 billion from the gilt offerings to date in 2011-12.
Strength of the market
Robert Stheeman, chief executive of the DMO, says he believes the new gilt is the longest-dated sovereign inflation-linked bond in the world. "It has extended the UK real yield curve by almost seven years and represents the largest ever sale of duration to the gilt market,' he says.
He adds: "It is a testament to the strength of the gilt market and our investor base that we were able to build a very large book of high quality demand of £10 billion in 90 minutes and at a time of persisting global market volatility.
"The deal also represents good value for the taxpayer, with the real yield at the sale being the lowest at which the DMO has sold an ultra-long index-linked gilt."
Adrian Lowcock, senior investment adviser at broker BestInvest, outlines how retail investors can invest in gilts.
"Private investors can purchase the gilt through either a stockbroker, a high street bank or Computershare investor services, who run the DMO's Gilt Purchase and Sale Service, and are also responsible for maintaining the register of gilt holdings."
He adds that retail investors should speak to a financial adviser before investing in gilts. "Generally gilts do not look attractive at the moment as the interest offered on them is very low, so it would be worth considering alternative investments such as corporate bond funds where the managers can actively invest in a wider range of debt in issue," he adds.
Dean Aitchison, senior investment manager at Fiducia Wealth, says there has been a "marked increase" in demand for index-linked bonds as investors pile into products that beat inflation, but this, he says, has forced yields to historic lows.
"The Bank of England expects inflation to fall sharply early next year, so one must ask if now is actually a good time to purchase index linkers, particularly long-dated issues. Long-dated bonds are generally more volatile than short-dated ones, and the 2055 dated bond was more volatile than the FTSE 100 over the past six years (a period covering historically large losses from equities)," he says.
Aitchison adds that the most appropriate way for retail investors to gain exposure to bonds is via a well diversified fund.
"If investors can find a long-dated index-linked gilt fund this could be the best way to access this issuance," he says. "Retail investors should be able to purchase stock via a wrap platform or through a broker when stock becomes available."
Gilt yields are currently at all-time lows. During the ongoing market volatility, prices for bonds have gone up as investors piled into safe haven assets. The redemption yield on a 10-year gilt is 2.39%, while a six-year gilt has a yield of 1.59%.
This article was written for our sister website Money Observer
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.