UK gilt ETFs hit as yields reach post-Brexit highs

Oct 20th, 2016 | By | Category: Fixed Income

Investors in UK government bond exchange-traded funds have been hit by gilt yields reaching their highest point since Brexit this week.

UK gilt ETFs taking a hit as yields reach post-Brexit highs

Ten-year gilt yields struck 1.2% on 17 October, the highest level since 23 June when the UK voted to leave the European Union.

The yield on the 10-year gilt struck 1.2% on 17 October, the highest level since 23 June when the UK voted to leave the European Union, and more than double its low point of 0.52% on 12 August. The five-year yield has risen to 0.46% from a low point of 0.12% on 10 August.

Yields have risen due to several factors, including an increase of inflation – the official CPI figure for the UK in October was 1% – which erodes the real value of bonds’ coupon payments.

Another factor is the fall in sterling, which has steadily devalued over several months compared to its major trading partners. GBP versus USD dropped from $1.48 on 24 June to $1.22 on 20 October. Expectations of future devaluations in sterling decreases the attractiveness of UK gilts to foreign investors, thereby reducing demand and pushing yields higher.

The market also has a close eye on possible interest rate hikes in the US, which have a big impact on bond prices around the world. According to broker and investment firm Hargreaves Lansdown, markets are pricing in a two in three chance of rates being raised in the US in December.

Although year-to-date returns are in the black for most sterling-based ETFs that track gilts, these funds have headed south since mid-August, with longer-dated bond ETFs taking the hardest hit.

The SPDR Barclays 15+ Year Gilt UCITS ETF (LON: GLTL) is still up 20.6% since 1 January but has fallen more than 9% since 12 August.

The effect has not been so dramatic on shorter-dated bonds. The SPDR Barclays 1-5 Year Gilt UCITS ETF (LON: GLTS) is up just 2.5% year to date, and fell just 0.7% over the same period. Both funds cost 0.15%.

The largest ETF on the London Stock Exchange that tracks a mix of short and longer dated gilts is the £1bn iShares UK Gilts UCITS ETF (LON: IGLT). It costs 0.20% and has fallen more than 5% since 12 August. It holds 42 bonds with an effective duration of 10.9 years and an average weighted maturity of 15.9 years.

State Street Global Advisors offers a similar fund for a cheaper fee of 0.15%. The £110m SPDR Barclays UK Gilt UCITS ETF (LON: GLTY) is also down about 5% over the last two months. It invests in 40 bonds with an average maturity of 16.7 years.

The cheapest ETF in the gilt market is the Lyxor FTSE Actuaries UK Gilts UCITS ETF (LON: GILS) at just 0.07%. It has £106m in assets and holds more than 40% in bonds that expire in at least 15 years’ time.

Despite continued uncertainty as to the timing and impact of Brexit, income-hungry investors are likely to continue buying up UK gilt ETFs, says Laith Khalif, senior analyst at Hargreaves Lansdown.

“However, income-starved investors can only ignore rising yields for so long, before they get tempted in, which puts something of a floor under the bond market, particularly when pension funds are gobbling up all the gilts they can get.”

She added: “Of course bond yields are still exceptionally low, but anyone holding government bonds has seen their capital value fall since the market peaked in August, and by quite some margin for longer dated bonds.”

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