For investors, these are — quite simply — extraordinary times.
Take City of London Investment Trust (LSE: CTY), a higher-yielding investment trust often regarded as a proxy for UK plc. I’ve owned a chunk of it for years. Stolid and steady, it’s had the same manager — Job Curtis — since 1991.
But in the bond market rout of late September, the yield on 10-year government gilts came within spitting distance of what a stake in City of London would earn you.
And that, my friends, is simply crazy.
Risk premium
There’s a hierarchy in these things.
Equities — shares in companies — have a higher yield than bonds, to compensate for the higher risk.
Bonds — loan to companies, in effect — have, in turn, a higher yield than gilts (which are bonds issued by the UK government (and judged safer than bonds issued by companies. They’re called ‘gilts’ because back in the day, the certificates were gilt-edged.
Only in banana republics would one expect loans to the government to be regarded as risky enough to be on a par with equities.
But that, it seems, is where we are.
Crisis? What crisis?
I’m looking at a 40-year chart of 10-year gilt yields. At the start of that period, gilt yields oscillated in the 10–15% range.
Britain, you’ll recall, was ‘the sick man of Europe’. Strikes were endemic, the ‘Winter of Discontent’ still a raw, fresh memory, and prime minister James Callaghan’s custody of the economy yielded the immortal headline ‘Crisis? What crisis?’ — although Callaghan himself apparently never uttered those words.
The markets’ reaction to Liz Truss’s inaugural mini-budget would have been all too familiar to Callaghan: soaring gilt yields, rising interest rates, and plunging share prices.
Sure enough, at the other end of that 40-year chart — the last two weeks, in other words — the ten-year gilt yield chart rockets skywards like something built by Elon Musk’s SpaceX.
As recently as January, the 10-year gilt yield was 1%. Now, it’s hovering around 4%.
Bargain — or falling knife?
What should investors do?
Now, gilt yields rise because gilt prices have fallen. And sure enough, gilt investors have suffered heavy losses.
And I’m sure some investors are thinking of buying into that dip — although ‘crash’ is a better word than ‘dip’ in this case. Nor is it difficult: just about every fund supermarket will have funds offering exposure to gilts.
But I’m not so sure that this would be a good idea.
Despite the U-turn on the higher-rate tax cuts, the public finances are still wobbly. The other unfunded tax cuts remain. Government borrowing costs have been driven up, just when Liz Truss has announced a huge splurge of further debt to fund subsidised energy for households and businesses, stamp duty cuts, and a reversal of higher corporation taxes.
Investors may need to wait a long time for gilt markets to recover back to yields of 1% or so. And in the meantime, the yield they’re getting is running at around half the level of inflation — and with holding to redemption the safest strategy, the capital risk in real terms could be significant.
And unlike dividends — which can rise — gilt (and bond) yields are locked in at the time of purchase. What you buy is what you get.
Equity upside
Equities, to my mind, remain the better bet.
Which equities? Me, I’m tempted to throw a little more money at City of London Investment Trust — where the dividend has risen without a break for 56 years.
