Gilts look attractive, but trusts have more income growth potential
Yields on gilts have reached levels not seen for 16 years, but with real yields still negative, investors should look to trusts instead.
The yields on gilts have jumped to highs not seen since before the financial crisis only adding more fire to the chorus of stockbrokers, wealth managers and financial advisers urging their clients to buy short-dated gilts.
They point out that if you buy a low-coupon gilt, such as Treasury 0.125% redeeming at the end of January 2026, and hold it to redemption, you are guaranteed a return of over 10%, equivalent to an annualised return of around 4.5%.
Nearly all this return will be capital gains. Though holders are liable to income tax on the negligible coupon, capital gains on gilts held for more than a year are tax-free. For a higher-rate taxpayer, an annualised, virtually tax-free, return of almost 4.5% might sound compelling.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
However, with inflation, though falling, still at 6.7%, real yields are still firmly negative. The return of the 2026 Treasury until maturity should exceed inflation, but not by much. Moreover, the credibility of the Bank of England as an inflation-fighter is far from proven.
The US Federal Reserve waited till inflation had fallen below interest rates before pausing its rate rises and warned that further increases remained on its agenda should inflation persist.
The Bank of England, however, paused while rates were still below inflation and it will be very difficult to resume the hiking cycle. Anyone investing on the basis of further significant and permanent falls in inflation should be wary.
Gilts do not provide inflation-busting income
The two-and-a-quarter-year return of 10% may be risk-free but investors should be able to do better. Despite the stellar performance of a few US tech-related mega-caps, 2021 and 2022 have been disappointing for most investors.
As Ed Yardeni points out, analysts are now raising forecasts of future revenues and earnings. Though S&P 500 revenues per share are up 7.1% year on year, operating earnings per share are down 5.4%. But Yardeni expects operating earnings to rise 3.2% for 2023 as a whole, 11% next year and 9% in 2025.
For the S&P 500 to fall over the next two years or return less than 10%, the market would have to be de-rated from 19.2 times this year’s earnings and 17.3 times next.
Other markets, such as the UK, have significantly lower valuations but are also likely to see lower earnings growth. This is possible if bond yields rise as a consequence of inflation surprising to the upside but that would also be negative for the inflation-adjusted return from gilts.
Much more likely is that global stock markets will deliver a return of well over 10% by the end of January 2026 and probably over 20%. Investment trusts, currently trading on high discounts to net asset value, should do even better. Those who wait for their short-dated gilts to mature will probably miss the boat.
Trusts offer value
Those worried about unbalancing their portfolios by switching to “risky” equities rather than “safe” gilts have another option. Infrastructure funds such as BBGI Global Infrastructure, HICL Infrastructure and International Public Partnerships yield between 5.5% and 6.5% and are likely to continue to increase their dividends broadly in line with inflation. Most of the renewable energy sector yields more, but continued weakness in UK electricity prices could hit dividend growth.
Some of the debt funds, such as TwentyFour Income Fund, yield over 10% though they will find it more difficult to increase dividends. High and rising yields are also available among property REITs; TR Property yields 5.5% but has raised its dividend at an annualised 5% in the last five years while yields above 7% among the specialist funds are common.
Yet the City has been selling these funds, hence their poor performance this year and wide discounts to net asset value. Smart investors should do the opposite.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
-
Do you qualify for the Winter Fuel Payment if you live abroad?
The Winter Fuel Payment will be means tested for expats living in Europe, in line with the new rules impacting those in the UK. But a quirk in the system means not all countries are eligible.
By Katie Williams Published
-
What the Employment Rights Bill means for your job
New workplace reforms are set to give employees new rights to benefits and flexible working
By Marc Shoffman Published