A Decade Of Fun With Gilt Funds

Published in Investing Strategy on 11 September 2009

Gilts have posted great returns over ten years, but not every fund manager has done equally well from the bull run in government bonds.

Last week we looked at the superior returns of gilts versus equities over the past ten years.

Gilts have delivered a real (i.e. inflation-adjusted) annual return of 2.4% a year for the decade to the end of 2008, compared to -1.5% a year for equities.

Not so much a case of the tortoise and the hare, as the tortoise versus the dead parrot!

Any investor who thought the stock market was irrationally exuberant in the late 1990s and switched his money into gilts would have done very well, especially compared to riding the ups and downs (mostly downs) of the FTSE 100.

How well? The data I've quoted from Barclays Capital above is all good and proper, but we can't invest in data -- we buy assets or pool our money into funds, which risk deviating from the theoretical returns.

Funds in the sun

Some private investors buy gilts directly, but many invest via funds.

And according to CityWire, the average unit trust in the Gilt sector has delivered a total return of 60% over the past decade to the end of July -- comfortably beating most FTSE 100-focused equity funds.

A few funds did much better than others, as the following tables illustrate:

The three best gilt fund performances…

 5 year total return10 year total return
Allianz PIMCO Gilt Yield A Inc36%71%
Royal London UK Government Bond32%68%
Legal & General All Stocks Gilt Index Trust Inc31%65%

…and the three laggards:

 5 year total return10 year total return
Gartmore UK Long Dated Gilt Inst Acc26%53%
Scottish Widows Gilt A Acc23%47%
Threadneedle Sterling Bond C120%45%

For better or for worse

You might well wonder why the best performing gilt fund returned 71% over the decade, when the worst managed only 45%.

Aren't gilts relatively simple and safe investments that generally move as a block in response to inflation and interest rates, as well investors' appetite for risk and security?

All true, but there are several ways fund returns can still vary:

Gilts selected – There are numerous gilts issued by the government, offering a variety of durations and coupons, and fluctuating in value according to market conditions. The precise mix of gilts favoured by a fund -- and thus its eventual return -- is down to the manager.

Trading – Active managers justify their salaries on their ability to outperform their markets. A gilt fund manager might correctly judge short-term gilts are set to be favoured over longer-term ones, for example, and shuffle his portfolio ahead of time. Or he could get it wrong. Over time, such changes will increase or reduce returns.

Expenses – Whether he makes the wrong call or the right one, trading incurs your fund manager -- or more accurately your fund -- execution fees.

Charges – Expected returns from gilts are generally rather low (discounting last year's extraordinary double-digit gain) and so expenses for unit trusts focusing on gilts are somewhat lower than for equities. Yet even charges of around 0.75-1% a year will eat into returns, while variations will result in diverging performances over several years.

It goes without saying that any initial charge for a gilt fund should be fended off with as long a bargepole as you'd use for a share one. Buy through a fund supermarket to cut such performance un-enhancing fees.

Doing gilts your way

If you'd put your money into the worst performing gilt fund and the Jones' next door had picked the best, you might be rather miffed at your managers' poor showing

But picking a superior government-bond fund manager ahead of time must be even harder than choosing an equity superstar.

One alternative is to buy and hold gilts directly. You'll have to pay commission to your stockbroker, but at least you'll cut out the management charges and, short of the UK defaulting, you can be sure of your return at the outset, since there'll be no meddling manager involved. Buying gilts directly can also have tax advantages.

But which gilts to buy? Freeing yourself of annual charges is one thing, but there's no guarantee you're going to be any better at reading the economic runes than the full-time fund manager you fired. You're probably better off buying to match gilts to future financial requirements (school fees, for example) than actively trading the bond market.

A way to reduce charges while ducking such decisions and retaining a broad exposure to gilts is to use a gilt index-tracker fund.

UK investors aren't exactly spoilt for UK government bond exchange-traded funds, but you could investigate the iShares FTSE All Stocks Gilt (LSE: IGLT) or the shorter duration FTSE Gilts 0-5 (LSE: IGLS).

Both charge just 0.2% a year.

Guilt-free investing

Personally, I'd rather buy tulip bulbs than go overboard on gilts right now. Yields are just too low.

The one big advantage of holding gilts despite their low yields -- that they can still protect against deflation -- can be partly achieved by holding cash, unless we see negative interest rates. I don't think deflation is likely, anyway.

The other advantage is security of capital, but the UK government has repeatedly stood behind cash deposits, so why take on extra risk with gilts?

With gilts beating equities over ten years, I think a reversal is most likely, whatever the immediate debates about inflation versus deflation or the economic recovery. Gilts are traditionally for cautious investors, but they look risky today -- however you hold them.

More from Owain Bennallack:

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curedum 11 Sep 2009 , 3:40pm

For the smaller investor, good old National Savings Certificates also guarantee a fixed return which is tax-free; especially useful for higher-rate tax payers.

gordonbanks42 11 Sep 2009 , 8:22pm

And for those interested in index-linking their returns, the NS&I Certs offer a guarantee that the inflation adjustment will never go negative (useful if deflation did set in) whereas index-linked gilts carry no such guarantee.

Iniq 15 Sep 2009 , 9:31am


"The one big advantage of holding gilts ... can be partly achieved by holding cash ...

... The other advantage is security of capital, but the UK government has repeatedly stood behind cash deposits, so why take on extra risk with gilts?"

I wish to take full advantage of my annual ISA investment alowance, and as an elderly investor seeking simplicity, stability and security above all else, I would love to be able to invest 100% in cash ISAs. If I wish to use my stock-and-share ISA allowance as well, am I right in thinking that using it to buy gilts (or more probably a gilt tracker fund) is about the nearest I'm going to get to investing in cash?

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