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From time to time, experts offer index linked Gilts as the safe solution to investment needs. The understanding of index linking varies widely, so here are the basic points:-
1. The capital value at which repayment occurs is indexed in line with the Retail Prices Index (RPI) from a set base until 8 months before redemption. A price "above 100" means nothing in isolation from the capital indexing formula. This is quite different to conventional Gilts, which are always repaid at 100 (the price of all Gilts is expressed as a percentage).
2. Half yearly income is also indexed. The coupon is increased proportionately with the change in the RPI. For example, if total indexation to date is 3% then the income payment is 1.03 times the original coupon, not the original coupon plus 3%.
3. Indexing works downwards as well as upwards. Note the difference compared to index linked savings certificates - the latter have a minimum return built in, whereas index linked Gilts have no minimum return.
4. The capital value can fluctuate above or below the current repayment value, just as conventional Gilts can go above or below 100.
As readers of Contraryview well understand, we believe the future is deflationary. So we do not recommend index linked Gilts at all. They are unsuitable for deflation! The whole point about exploiting the long term trend is to project today's yields into a future environment that will be like Japan - no interest on cash, negative inflation -which will make a fixed income of nearly 5% today look as good as 8% was a few years ago.
As always with capital markets, the best prices are when nobody wants to know, while the worst prices are when something is popular. Currently index linked are popular while soothsayers worry about inflation. You can draw the appropriate conclusion!
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