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Index Linked

November 15th 2019 – Written by Andrew Chorley

Index Linked 

We wrote a few weeks ago outlining our thoughts on a potential timing strategy that not only produced superior returns but also reduced risk; building on this, we thought we would explore this concept with other assets. 

Historically we have recommended holding UK Index Linked Gilts and US Treasury Inflation Protected Securities (TIPS) that have delivered excellent long term returns as capital and income is linked to inflation. When we started exploring the types of returns that had been received we started to consider whether a simple buy and hold strategy for this could be improved upon. Starting in 1997 we established the following - 

 

Asset

Value of £10,000 Invested in 1997

Total Return

Annualised Return

Index Linked Gilts 

£51,631

416%

7.57%

TIPS 

£40,563

306%

6.42%

50% Index Linked Gilts 50% TIPS

£46,097

361%

7.03%

Indices used FTSE Actuaries UK Index Linked Gilts TR and ICE BofAML US Inflation Linked Treasury TR

 

Previous research we had undertaken showed that returns when the yield on TIPS was higher than Index Linked Gilts the future returns increased and vice versa; using this we tested different scenarios and found that the following strategy enhanced returns. 

 

  • Compare the difference in the yield by deducting the yield on Index Linked Gilts from the Yield on TIPS 
  • When the difference in yield is above its long term median for two months invest in TIPS 
  • When the difference in yield is below its long term median for two months invest in Index Linked Gilts 

 

Between 1997 and now this produce a total of eleven signals to buy or sell on each of the assets; the results showed that on eight occasions the asset that was bought outperformed the asset sold by anything from 1.07% to 18.74%. The results were then compared to the other strategies and the we found that - 

 

  • The value of £10,000 invested in 1997 and following the strategy would now be worth £62,687
  • The total return increased to 527% 
  • The annualised return increased to 8.5% 

 

Analysing economic data and the outlook for inflation is complex and time consuming; its important to consider where inflation is heading but sometimes a simple indicator can help and produce more than satisfactory results.  

EST. 1999