Oliver Smith, portfolio manager at IG Group, takes a look at recent trends with regard to UK government bonds and gives his view on the best funds available.
UK government bonds have always been regarded as a safe way to invest money as the likelihood of the UK government defaulting on its own debt is very low. A well-known example of a sovereign state defaulting on its own debt was Russia in 1998 (Greece technically did not default in the 2010s), which caught the market by surprise and precipitated a financial crisis. The reason a UK sovereign default is highly unlikely is that the Bank of England (BoE), unlike Eurozone member states, can simply create new money to finance the government's obligations.
While default risk is low, it doesn't mean that there is no risk. As a rule of thumb, the longer the maturity of the debt, the greater its duration or sensitivity to interest rates. Therefore, long-dated debt is more susceptible to short-term losses when interest rates rise.
Investors in bonds need to take into consideration the shape of the yield curve, which we can see in the image below. The yield curve is currently upward sloping, but from a very low base level. Short-dated government bonds yield very little (0.1% for a two-year bond), while longer dated maturities have a higher yield, but offer significantly less income than they did in the past.
In terms of the available exchange traded funds, investors can purchase short-dated gilts, ETFs covering the entire range of maturities, and long-dated gilts. We list one of each below.
For investors wanting to get exposure to government bonds in other currencies, ETF providers offer exposure to a range of different countries and currencies, which can be bought or hedged into sterling, or unhedged, which means that changes in exchange rates will have a large impact on performance.
IG's Selections:
Lyxor FTSE Actuaries UK Gilts (GILS) For investors wanting exposure to the entire yield curve, GILS has a total expense ratio (TER) of just 0.07% and has physical exposure to the underlying securities in the index. It yields 1.6% and has a duration of 10.8 years, meaning investors must be prepared for capital losses if the yield curve rises.
SPDR Barclays 15+ Year Gilt UCITS ETF (GLTL) This ETF targets the long end of the yield curve, and has the highest yield to maturity of the six ETFs at 1.67%. The average maturity of the underlying bonds is 28.7 years, but more importantly, the effective duration is 19.55 years - making it very sensitive to changes in interest rates so larger capital losses, or gains, are likely if interest rate volatility rises.
iShares Global Government Bond UCITS ETF (IGLO) This ETF gives exposure to G7 bonds, including Canada, France, Germany, Italy, Japan and the US. It is not currency-hedged, meaning that should sterling gain in aggregate against those countries' currencies, investors will likely make losses. It has a yield to maturity of 1%, and a TER of 0.2%.
db x-trackers II Global Government Bond UCITS ETF (XGSG) Investors seeking GBP-hedged exposure to global bonds could consider this ETF from the db x-trackers range. It has a broader remit than IGLO with exposure to 19 countries through the Citi World Government Bond Index. The TER is 0.25% and it has a yield to maturity of 0.96%.
Lyxor iBoxx $ Treasuries 1-3yr UCITS ETF (U13G) For many people, US dollars are the ultimate refuge in times of crisis. A sterling investor can buy the GBP share class of this ETF to get exposure to the USD, which eliminates the need to pay broker FX fees. Lyxor has made a real push to lower its fixed income fees, and this ETF has a TER of just 0.07%.
