Gilty Pleasures

Published in Investing Strategy on 2 September 2009

Investors in safe but boring gilts have beaten the stock market for two decades.

In 2001, a German professor named Hans Juergens shocked the world when he revealed that -- contrary to expectations -- men saw blonde women as lifelong partners, whereas brunettes were preferred for a walk on the wild side.

TV advertising was to blame, apparently. For two decades men had been blasted by commercials where fair-haired mothers obsessed over whiter than white underwear, whereas brunette actresses pushed dark chocolate and red wine.

In just a couple of generations, Unilever (LSE: ULVR) had undone all Marilyn Monroe's hard work.

Sexist the research may have been -- for men as well as women -- but it also touched a nerve, with the German anthropologist enjoying headlines around the globe.

Here comes the science bit

Earlier this year, the Barclays Equity Gilt Study 2009 revealed something even more topsy-turvy and counter-intuitive than men plumping for Pamela Anderson over Carla Bruni for motherhood. 

Yet you won't see many headlines in The Sun or even The Guardian about the 20-year record of government bonds. Their loss, because the story really is a shocker. UK gilts and US treasuries have soundly beaten equities over the past two decades.

UK real investment returns

 200810 years20 years50 years
UK equities-30.5%-1.5%4.6%5.7%

Note: These returns (and those below) are adjusted for inflation

Is the poor showing for UK equities a result of our overly defensive stock market, which often lags the rest of the world? Hardly -- the story is the same in the go-getting US.

US real investment returns 

 200810 years20 years50 years
US equities-38.9%-2.7%5.6%5.1%

Boring bonds, big returns

Government bonds beating equities has big implications.

For a start, a less than 1% annual differential in performance may not look like much but over the long term small differences really add up.

  • If you'd chosen to invest £100,000 in UK equities on the first day of 1989 -- the year of Pamela Anderson's PlayBoy debut, incidentally -- then by the end of 2008 you'd have amassed an inflation-adjusted £245,829 (ignoring costs and tax).

  • If instead you'd chosen to the dowdier option of investing (and reinvesting) in gilts, you'd have £291,776 in today's money (again ignoring costs and taxes).

That's a difference in return between equities and gilts of £45,947 -- or nearly 20% -- in favour of the government bonds over a 20-year period.

Gilts' unfair advantage

The excellent return from gilts over the past 20 years isn't just a big deal because you'd have ended up with more loot. The key point is by investing in gilts, you'd probably have more hair left, too, and you'd have fretted away far fewer sleepless nights.

Stock market investors over the past 20 years have lived through two deep bear markets, plus innumerable scare stories, from the Asian currency crisis and two Gulf Wars to avian and latterly swine flu.

Gilt investing isn't risk-free over the shorter term, since their prices fluctuate. But gilts do virtually guarantee you'll get your money back at the end of their term, plus the regular income you're due until then.

The UK government has never defaulted on its debt. You'd have had to be a worrier of epic proportions to be spooked by your gilt holdings.

Now in investment terms, it can be considered very 'unfair' that gilt holders got superior returns while taking on less risk than investors in equities. Equities are 'supposed' to compensate holders for their volatility by delivering better returns over the long-term.

The table above shows equities have indeed beaten gilts -- provided you go back 50 years. But unless you started investing when you were 15 years old, that's rather cold comfort.

It's like marrying a blonde glamour model in expectation of a lifetime of wild and racy times, only to discover 20 years later that your friend who hitched up with a mousy librarian had more fun.

Gentleman prefer bonds?

Will gilts beat equities over the next 20 years? Firstly it depends on how precisely you want to measure it.

The 20-year returns from government bonds to the end of 2008 are hugely boosted by the flight-to-safety that occurred in the panic of last year, which also of course slashed the return from equities.

We'd be very unlikely to see similar conditions on the 20th anniversary of this article -- and even Barclays' Equity Gilt Study for 2010 looks on-course to paint a different picture to the end of 2009, thanks to this year's stock market rally.

History is on the side of equity investors, too. There have only been three years in the previous 100 when gilts beat equities over a two-decade long holding period, so share investors are due for a break.

That said, prices for UK government bonds are still holding up, with the 10-year gilt yielding 3.52% and the 30-year gilt 4.10% -- low figures in historical terms that suggest an ongoing appetite for UK government debt.

To justify buying gilts at these prices, bond bulls point to everything from super low inflation to quantitative easing and the demand from pension funds.

Personally, I expect normality to return over the next few years.

Just as the covers of the lad's magazines in WH Smith (LSE: SMWH) are still dominated by blonde beauties years on from Professor Juergens' findings, so gentleman (and lady!) investors should prefer equities for the long term.

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Iniq 03 Sep 2009 , 2:01pm

Do the figures include the re-investment of dividends?

Iniq 04 Sep 2009 , 10:56am

If an investor wises to buy gilts - say, perhaps as a way of using his annual Stock-and-Share ISA allowance but without the volatility of equities - is it better to invest in gilt funds, or in gilts directly? If in gilts directly, how does one go about putting them within an ISA wrapper, please?

gordonbanks42 04 Sep 2009 , 12:53pm

@Iniq: If you want to buy gilts directly to hold in an ISA, you'll need a wrapper operated by a stockbroker. Your existing wrapper may or may not do the job. Once you have a suitable wrapper, you just instruct the broker to buy what you want and they will charge you their usual dealing commission according to the value bought. (There is a list of all the gilts in issue on the DMO web site.) The broker may also charge you an annual custody fee to hold the gilts in your ISA. Best to choose one that doesn't do that.

If you want to hold gilts in the form of bond fund units, then any ISA wrapper that gives you access to a fund supermarket will do the trick, or an ISA wrapper operated by a fund manager who does bond funds. You'll get more choice with the fund supermarket approach than the single-fund-manager approach, obviously. Watch the AMC/TER on those funds, as they can take the shine off your returns.

Bear in mind that gilts with less than 5 years to maturity may not be held in a Stocks and Shares ISA (because they're too much like cash), and there are also certain gilt funds whose portfolios are too "short" to be permitted in a SnS ISA. The website of the ISA wrapper operator will probably tell you which those are. L&G does a Gilt fund with an amazingly low TER, but you will find that the minimum investment is £100K. I was rather disappointed when I discovered that!

Also bear in mind that if you go the gilt fund route, your returns wil be determined at least in part by the trading decisions made by the fund manager. If you buy a gilt directly, you have the option to hold it to maturity, thereby achieving certainty of both income and capital return (except in the unlikely case of HMG defaulting, of course). If you buy units in a fund, the price will go up and down and when you want your money back you'll have to cash in at the price ruling on the day, whatever that is. Look at a 5-year price graph (or longer if you can find one) for any fund you might consider and ask yourself whether the downs are too down for your comfort.

I have no gilts or gilt fund units in my ISA, but I do have some longish-dated index linked gilts in my SIPP, which I intend to hold to redemption. I chose the duration to match my intended "retirement" date. I also have some units of HSBC's Gilt & Fixed Interest fund in my SIPP. The latter are handy for making periodic adjustments to my bond allocation, since there is no bid/offer spread and no initial charge, so I can buy and sell smaller amounts at no cost.

gordonbanks42 04 Sep 2009 , 1:04pm

@Iniq: I just realised that in writing the above posting I have assumed that a gilt fund would necessarily be of the AUT/OEIC type. That's not quite true.

There are some ETFs that track gilt indices, so you could invest in gilts indirectly that way too. The mechanics of buying and selling them are the same as for direct equities. In most respects they behave like an AUT/OEIC-based gilt fund would. The differences are (1) you will always pay buy/sell commission (2) there will always be a buy/sell spread (3) you may be charged a custody fee, if your ISA operator does that for direct equities.

I would not use this route because it seems to combine the disadvantages of both of the other two methods. That's probably why I overlooked it first time round.

RobinnBanks 05 Sep 2009 , 11:55pm

How is it that Barclays keeps telling us that equities have beaten everything over the last millenium and returned 11% per annum, or something like that?

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