To go short- or long-dated is probably the biggest strategic decision a bond investor needs to make and getting the balance right is the key to successful fixed income investing. Longer-dated bonds show greater sensitivity to shifts in yield, which is good news in a bull market when buying securities of ten, twenty or even thirty years will provide an investor with a safe form of gearing. However, in a falling or uncertain market, long-dated bonds can be a worry and with fears over a hung parliament and the pressure on sterling, the gilt market has clear potential for another "leg down".
In theory, price volatility is less of a problem for bonds than it is for equities, since bonds have a fixed redemption date and price, and can held oblivious to the ebb and flow of the secondary market. Nevertheless, sitting on an unrealised loss is not a nice feeling and, at present, the holders of longer-dated gilts have cause for concern. The yield on these securities is modest in absolute terms at around four per cent, but a month or two of negative price movements could quickly wipe out this return. If the calculation is based on the height of the June-Dec gilt range, this move might be as much as another four points lower.
The table below shows the effect on the price of a 1, 2 and 3 per cent shift in the yield on three benchmark gilts:
| Gilt | Life | Price at 3% | ...at 4% | ...at 5% | ...at 6% | % price range |
|---|---|---|---|---|---|---|
| UKT 4.75% Sep 2015 | 5yrs | 108.82 | 103.68 | 98.81 | 94.21 | 13% |
| UKT 4.75% Mar 2020 | 10ys | 115.04 | 106.14 | 98.05 | 90.69 | 21% |
| UKT 4.5% Dec 2042 | 32yrs | 131.15 | 109.08 | 91.98 | 78.60 | 40% |
If you're looking for alternatives to gilts, you might want to consider the following corporate or 'supra-national' issues:
| Issuer | Coupon | Maturity | Market price | YTM | Rating |
|---|---|---|---|---|---|
| EIB | 4.375% | Jul 2015 | 106.25 | 3.1% | AAA |
| RBS "Royal Bond" | 4.3% | Aug 2015 | 103.35 | 5.1% | A+ |
| Unilever | 4.75% | Jun 2017 | 104 | 4.1% | A+ |
See other bond of the week features.
