The prospect of a UK recession has reared its head after official figures revealed the economy contracted by 0.2% in the second quarter of the year.
The worry is that the economy’s performance in the third quarter may be negatively impacted by the mix of ongoing Brexit uncertainty and a worsening global outlook. Indeed, Brexit is not helping the situation, with the likelihood of a recession put at one-in-three in the event of a no-deal Brexit at the end of October.
Of course, economic forecasting is far from being an exact science. And faced with Brexit’s unnerving capacity for surprising twists, predictions are nowadays subject to a larger margin of error than usual. However, growing angst as we approach the Brexit deadline is likely to on UK equity markets while encouraging expectations for defensive monetary policy action.
These volatile times are always a handy reminder of the important role that fixed income investments play in an investment portfolio as a counterweight to often more volatile equity holdings.
With yields trending ever lower, it’s hard to make an income case for bonds these days. But irrespective of the market environment and our risk profile, bonds issued by highly credit-worthy governments such as the UK’s are still seen as part of an optimal mix of asset classes in a portfolio. In essence, they are akin to buying an insurance policy; one that we maintain for the long-run and can tweak to fit the various cycles of our investing life.
Given their core role in a portfolio, investors should consider low-cost passive options as a way to gain exposure to UK gilts. This is a market where opportunities for active managers to add meaningful value are limited, and thus keeping a tight rein on the annual fees we pay for a fund becomes a top priority.
There is no shortage of passive options to choose from and, luckily, this has been one of the few areas in the passive bond fund space where we have seen fee competition between providers, which helps to bring costs down.
In fact, BlackRock has just cut the ongoing charge for the Silver-rated iShares UK Gilts All Stocks Index Fund from 0.16% to 0.11%, undercutting all its rivals. The fund has produced an annualised return of 5.9% over five years and yields 1.5%.
Earlier in the year, the firm had cut the fee for the also-Silver-rated iShares Core UK Gilts ETF (IGLT) down from 0.20% to 0.07% to bring it in line with the cheapest ETFs in this space. It has produced an annualised return of 5.8% over five years and yields 1.2%.
UK Gilt ETFS
Fees across the ETFs in this space are more widely spread, with charges on the SPDR Bloomberg Barclay UK Gilt ETF (GLTY) more than double the cheapest option, the Invesco UK Gilts ETF (GLTA).
UK Passive Funds
Fees on the passive funds are slightly higher than most of their ETF counterparts, ranging from 0.11% to 0.15%. This is despite the fact that their assets dwarf their ETF rivals, with the iShares fund managing a hefty £5 billion.
Passive funds offering exposure to the UK gilt market typically track the FTSE Actuaries or Bloomberg Barclays Gilts indices. There are minor differences in the construction rules of these indices.
The UK gilt market is small, and a fair share of the bonds is in the hands of long-term institutional investors such as pension funds. In that sense, the float-adjusted index approach - ie. what is actually available to invest in - followed by the Vanguard funds provides a more accurate representation of what is truly available to buy in the secondary market. This has given it an edge in performance terms relative to a standard market-cap-weighted approach in the last decade.
However, irrespective of index, passive funds in this category have tended to deliver above-average returns over the long-term on a risk-adjusted basis. That is why all the UK gilt passive funds that we rate have been awarded a Morningstar Analyst Rating of Silver.
