This is the personal view of Cliff Weight and does not represent the views of ShareSoc. Cliff Weight is not authorised to give financial advice and nothing in this article should be interpreted as advice.
The 13 year Quantitative Easing* experiment has finished. Between March 2009 and June 2022, the Bank of England bought 57% of the £1.5trillion of gilts sold, according to the FT see https://on.ft.com/3xcx6mL
I feel more comfortable. The laws of economics I was taught at university in the 1970’s and learnt thereafter give me a framework to understand what is happening, which for the past 13 years they did not.
Instead of 0.25% interest rates, we now have gilt yields of 3.1%, having surged from 2% in early August. Gilt yields are projected to rise to 4.2% next year.
The expected risk premium of say 5% or 6% gives an expected return of 9 or 10% p.a. Of course, with equities nothing is guaranteed and we must always remember that on average one year in six the market declines. I found some good stats on market returns here from this webpage from IG Group – who are Sponsors of ShareSoc’s Investing Basics course (which is due to be released shortly) https://www.ig.com/uk/trading-strategies/what-are-the-average-returns-of-the-ftse-100–200529
I have written before about the 30 year bull market in gilts and bonds and warned that projecting that trend to continue was high risk and in my opinion unlikely to be a successful strategy.
Those who thought gilts were a “safe” investment will have seen their investment lose 25% of its value in the past 12 months (see https://www.fidelity.co.uk/factsheet-data/factsheet/IE00BH04GW44-vanguard-funds-plc/performance).
A comparison of iShares Global Corporate Bonds and Vanguard UK gilts for the period 30/6/20 to 30/6/21 showed similar declines by c 6% and 7% respectively, but for the period 30/6/21 to 30/6/22 the Bond ETF went down 6% whilst the (supposedly safer) gilts ETF went down 15.5%. (Source Fidelity website).
Those who have adopted the benchmark 60/40 model of equities to bonds, will have seen their bond portfolios decimated of late.
There is one important silver lining. The discount rate for pension liabilities is based on the risk free rate (in my view a bizarre bit of accounting for the past 15 years when Quantitative Easing produced anomalous results). As the risk free rate has increased, these “liabilities” have shrunk hugely. Expect lots of pension holidays and profit jumps as pension write backs may occur. Companies with large pension deficits may be worth looking at.
QE has led to a huge transfer of wealth to those able to borrow at low rates and invest in good companies. It was the very rich who did best. Private Equity and tech were particularly good places to invest. It will be interesting to see what will be the best places to invest in the next two decades.
*The introduction of new money into the money supply by a central bank.
A few points on this article:
Firstly, the risk premium and return refers to the required return, to compensate for the risk of holding equities relative to gilts. It does not mean that equities bought now are likely to produce that return. On the contrary, it may mean that equity prices need to fall from current levels, in order to generate that level of return in the future.
Secondly, it’s important to understand the significance of “duration” in bond prices. The 25% fall referred to relates to a basket, undoubtedly, of longer dated gilts. Long dated gilts bought on low yields have considerable short-term risk. Gilts closer to maturity will not be so vulnerable because, if held to maturity, they’re guaranteed to repay their par value. See my report on the BIPS bond fund, here: https://www.sharesoc.org/agm-reports/invesco-bond-income-plus-bips-agm-2022/, where the fund manager reported shortening the duration of the investments in the fund over the course of 2021 and through into 2022. As the bonds in BIPS’ portfolio mature, they will be able to recycle capital into higher yielding securities (if current market conditions persist).
At a more direct level, I have invested in Enquest’s recent 9% bond issue (ENQ2), which matures in 2027. That seems like an attractive return, as long as Enquest doesn’t run into financial difficulty, which seems unlikely given the oil price outlook and strong cashflows currently being generated. Those bonds have declined to around 97% of par since issue but are unlikely to fall much further, as long as the market remains confident that they won’t default, given the relatively short maturity.
Useful clarifications. Thank you.
6 weeks later I re-read my comments on the end of QE. Whilst my analysis of pension surpluses was correct, I had not analysed both solvency and liquidity. I had not expected the need for a £75bn bailout of the pension funds due to the move to LDI, which was supposed to reduce risk!!!
This highlights a larger problem. Pension funds used to own 30% of the UK stock market and now own 6% (or is it less?). Partly (mainly) this is due to regulations. Is the reduced demand is one reason for the lower ratings of the UK market vis a vis overseas markets?
We now have a drive to make the UK more attractive for individual investors and overseas investors.
US treasuries 2 year bonds are no yielding 4.6%, much higher than in the UK but you might not know it if you only read the mainstream UK press. It is a strange world we live in. PS I dont give advice! But hopefully some readers value the insights and different views. The end of QE has led to chaos. Hopefully only in the short term.
update 3 years later:
UK 10 year Gilts are yielding 4.7%. US 4.24%
https://markets.ft.com/data/bonds/tearsheet/summary?s=UK10YG
Update June 10 2025
UK 10 year Gilts are yielding 4.57%. US 4.48% UK slightly higher than US.
I note that my blog https://www.sharesoc.org/blog/investment-strategies/asset-allocation-index-investing-vs-stock-picking/ does not address the dangers of the 60/40 approach nor does my other article or choosing your benchmark https://www.sharesoc.org/blog/investment-strategies/risk-returns-and-optimising-performance/
i have done some thinking about this recently, prompted by some comments from an investment guru friend. If you have adequate dividend income from your portfolio to meet your annual expenditures, then you should be invested 100% in equities (apart from your emergency fund which by definition has to be in cash or very near cash in liquid investments) and anything less than this is a sub optimising investment strategy. Investing in bonds rather than equities is institutionalised theft as such investors are persuaded to accept lower returns.
This activity is further encouraged by the tax deductibility of interest payments on debt, whereas equity dividends are paid from after tax profits. The 60/40 strategy has sub optimised individuals’ returns for at least the past 40 years. QE was a transfer of wealth from individual investors to the wealthy, that was hidden in plain sight; as the former were under-leveraged and the latter used huge leverage from cheap money.
There is a view that Trump is doing everything he can to trash the dollar, which is very dangerous since he is dependent on foreign finance to fund his deficits. Of course, you can print more money and that is the sort of thing that he would do, but then there would likely be a sharp fall in the dollar and a rise in rates which would bring all sorts of edifices tumbling down…
Typo. “or” in second line above should be “on”.