Index-linked gilts (also known as inflation-linked) can play an important role within an investor’s portfolio,and are a distinct asset class to conventional gilts.
While index-linked gilts have a higher duration compared to their conventional counterparts, this duration figure is misleading as inflation-linked bonds do not tend to move in line with their conventional counterparts. Key to understanding how these bonds will behave is knowing what the yield betas of your index-linked gilts are.
The yield beta is a measure of how much the inflation-linked gilt’s yield changes relative to a move in the conventional yield. We’ve plotted this on the chart below showing 10 year conventional gilt yields versus 10 year index-linked gilt yields. Between 2007 and 2009, the yield beta for index-linked gilts was 0.39, meaning that for every 1 percentage point change in the yield of conventional gilts, the index-linked gilt yield would change by 0.39 percentage points.
Source: Allianz Global Investors, Bloomberg, 05/01/2007-29/12/2017. Past performance is not a reliable indicator for future results.
What this means is that, despite often having a higher duration, the index-linked yield would move less than the conventional yield, reducing some of the interest rate risk on the bond. If you own index-linked gilts within a portfolio of conventional bonds, you can adjust the index-linked duration by the yield beta to get a comparable level of interest rate risk. If we use the yield beta to adjust the duration of a 10 year linker with that of a conventional, the effective duration of the linker comes out lower than that of the conventional, having been higher before.
The yield beta can change much more than this however, particularly when driven by large changes in inflation expectations, and hence breakevens. We can break down the latest of the above periods into 4 distinct periods, which gives us very different yield beta assumptions for each. Underneath the chart below is a table detailing the yield beta for each period.
Source: Allianz Global Investors, Bloomberg, 07/06/2013-29/12/2017. Past performance is not a reliable indicator for future results
|June 2013 – June 2016||0.49|
|July – August 2016||1.37|
|September – November 2016||0.34|
|December 2016 – December 2017||0.71|
Source: Allianz Global Investors, Bloomberg, 07/06/2013-29/12/2017.
Following the Brexit vote, higher inflation expectations meant that breakevens increased and index-linked yields moved more than conventionals. Conventionals then sold off aggressively as UK gilt yields were lifted with global government bonds in the run up to and following the US presidential election. Since then, the yield beta has been around 0.7.
Yield beta assumptions are crucial to understanding and forecasting the total return potential of your index-linked gilt allocation, and are important for calculating an index-linked bond’s interest rate sensitivity. Yield betas tend to differ for different maturities across the yield curve, and even across different countries’ inflation-linked bond markets. This has been one area of focus for our Allianz Gilt Yield strategy, the market-leading conventional gilt fund which has the ability to hold exposure to index-linked gilts1. We will also be launching a sister strategy in February which will primarily be focused on index-linked gilts – the Allianz Index-Linked Gilt Fund. Suited for investors with an index-linked allocation in their benchmark or who are looking for inflation-protection, the Fund will have an ‘early-bird’ share class with fees of 0.20%, which we believe to be very competitive with the passive funds in the sector
Further information on Mike Riddell and our Allianz Index-Linked Gilt Fund can be found by clicking here
1Since Mike Riddell and team took over management of the Fund, (30/11/2015-29/12/2017). The Fund is the top-performing conventional all stocks gilt fund in the IA Gilt Sector, Source data: Morningstar.
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