When 'safe-haven' gilts

look ghastly

Long-term investors in gilts are almost certain to lose money in real terms; we prefer various alternative investments

Inflation used to be the enemy of the investor. In the 1970s and 1980s, the major goal was to find investments that could beat inflation, which peaked at 26.9% in August 1976, and even as late as October 1990 spiked up to 10.9%[1]. 

The index-linked gilt market emerged in the early 1980s to protect investors against the depredations of inflation. If you expect to retire in 30 years’ time, for example, you can buy a 30-year index-linked gilt whose value is guaranteed to move with Retail Price Index inflation over the next 30 years, thus protecting your savings against inflation.

But this insurance has become expensive recently.  At the time of writing the 30-year UK index-linked gilt trades at a negative yield of -1.6% (see graph). So if you hold it to maturity the government guarantees you that you will lose about 23% of the real value of your investment over that period, measured via the Consumer Price Index (which we view as a better measure of the cost of living than the RPI).

This is one of the most remarkable distortions in the world of finance. By contrast, back in 1992, the yield on a 30-year index-linked gilt (UK government bond) was 4.6%, so investors were guaranteed to quadruple the real (inflation-adjusted) value of their money by the year 2022.


The madness of pension funds

Who would buy a gilt with a negative real yield?  The answer is simple: pension funds!  UK defined-benefit pension schemes have liabilities of £1.9tn (August 2016) linked to inflation by government regulation. They have an insatiable demand for inflation-hedging products that will help them manage their interest rate and inflation risk – albeit at the cost of losing their investors lots of money.  


We consider this to be highly unattractive. In our view, pension funds should favour risk assets like equities with positive expected returns in the long run. Unilever shares, for example, pay a 3% dividend and the prices of the firm’s products like Lipton, Magnum and Omo move quite closely with inflation.

The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

Index-linked gilts are an extreme case. But even conventional gilts offer little to investors. The 10-year, for example, yields 1.25% at the time of writing, even after a recent sharp rise. Like the Bank of England, we expect UK CPI inflation to average around 2% p.a. over the next 10 years, after being pushed up by the fall in sterling this year. In that case, investors in 10-year gilts can expect to lose 7% in real terms if they hold the bond until maturity.

Government bonds have traditionally been the bastion of defensive investing, providing inflation-beating returns to investors and often performing best when economies slowed or went into recession and equities were weak. At current levels of interest rates, though, we expect gilts to lose in real terms in most plausible economic scenarios, and have cut our holdings to a minimum.

Long-term investors in gilts are almost certain to lose money in real terms; we prefer various alternative investments


Instead, we are increasingly investing in alternative strategies – ways of generating returns that are not closely linked to the direction of equity and bond markets. These include:

  • Global macro, a ‘go anywhere’ approach seeking to benefit from macroeconomic trends across the world
  • Equity market-neutral, balancing long (positive) positions in promising companies and short (negative) positions in what are seen as the weakest ones
  • Trend-following, by which managers seek to buy when markets are rising and sell when they’re falling (see next article)

We expect that a basket of such strategies will outperform government bonds over two or three years and have a reasonably defensive returns profile, preserving their value in periods when equities fall.


[1] As measured by the Retail Price Index (RPI)  


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The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

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