Since January 2009 I have kept track of the financial data used to derive assumptions for FRS17/IAS19 disclosures. This is shown in graph form below:
The blue line is the yield on over 15 year AA rated corporate bonds, The red line is the yield on over 15 year gilts. The yellow line is market implied inflation: calculated as gilt yield minus index-linked gilt yield.
There are 3 things that I want to point out from this graph:
Firstly, and probably most importantly, gilt yields show little sign of going up. We haven’t even had much in the way of false dawns. Any spike in yields has quickly leveled off before resuming a downward trend. If trustees and sponsors are waiting for yields to rise, there is no knowing how long they will have to wait.
Secondly, the yield gap between gilts and AA bonds has been below 1% for the past 17 months. For those trustees who only use high quality bonds in their matching portfolio this means that a 50/50 glit/bond portfolio is only yielding 3.09% – this is the lowest yield since I started collating the data in January 2009 (when the composite yield was 5.73%).
Thirdly, the yellow line has been above the red line since they crossed 3 years ago – this means that index linked gilts have had a negative yield for the past 3 years. As at 28 November 2014 this stood at an astonishing -0.66%. This means that a buy and hold strategy on index-linked gilts guarantees a significant real loss against RPI.
So, where next for gilt yields?
Ask yourself these questions:
1. Can gilt yields get any lower?
2. Can the yield gap get squeezed any further?
3. How long will people accept a negative real return on their investment?
Now imagine you had asked yourself the same questions in December 2011.
Would you have said the same back then?
The future is notoriously difficult to predict and always has the capacity to surprise.