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Finance blog: Feeling gilty darling?

No, that is not a typing error in the title. Unfortunately, we get a little bit technical this week, and given the number of responses to last weeks question, a little more demanding on you. Next week will be easier, promise.

A week of many words from many facets of the financial community, not least the Chancellor with his pre-budget report on Monday of which more later.

Before commenting further, last weeks question and two snippets.

Last weeks question was about exempt gifts when dealing with inheritance tax. These gifts, which are exempt whether you make them during your lifetime or in your will, are gifts to four ‘classes' of people or organisation.

The first three are:

Your spouse.
UK Charities.
National Institutions such as National trust, museums etc.

What is the fourth?

The answer is (surprise surprise) Political parties. The winner was SF, who declined the prize, but perhaps this is appropriate given she is an accountant. To the others who didn't get it right, take solace in the fact neither did two other accountants. This weeks question is below.

Icesave & the Financial Services Compensation Scheme.

Credit where credit is due. Most savers have now received, or are in the process of receiving all of their savings returned to them via the Financial Services Compensation Scheme*. It was quick and savers were well informed via the internet. They were online accounts so the internet got them into a mess and then got them out of it. Well done the *FSCS although given that I have to pay into the scheme, I await news of next years contribution with some nervousness, especially as the regulators happily supervised the collapse in the first place.

Nationwide House Price Survey

Published on Thursday and reporting house prices fell by 0.4% in November, suggesting a slowing in the rate of fall. Over the last year then, prices have fallen by 13.9%, giving a net gain over 5 years of 27%. So what of the prophets of doom? Many ‘experts' predicted falls of 25-50%, and just 5 months ago, some dubious arithmetic was displayed in the Guardian to predict a fall of 47.5%. Now the ‘experts are suggesting it might only be 32% or so.

What will they say in another 6 months? All of this proves that the experts do not know as much as they would like us to think they did, but they are capable of some spectacularly ridiculous calculations and decisions. More about house prices and borrowing next week, because the banks need a whole raft of criticism devoted to them alone and we need to consider the Pre Budget Report.

Pre-Budget report

The government borrows to give us money and then taxes us to repay it. This is possible because Darling Alistair predicts all will be well in a year or eight. A system that has occurred for more than 150 years, and famously so to fund the war with France in 1815 so we leave it at that given that we have no control over it...or do we? Here is the technical bit.

When a government borrows, it does so by issuing bonds, and in the UK these are known as Gilts. The gilts are basically loan agreements, wherein the government promises (and does) make an interest payment twice a year, and at a point in the future recorded on the gilt, repays the debt. The UK Government has never defaulted on a gilt.

There are various forms, and they fall into groups of short (up to 7 years before being repaid), medium (7-15 years) and long (15 years or more.), and the within these, there are index linked and Fixed interest. There is a little more complexity but we can ignore that for the moment.

The institutional investors (pensions funds and the like) buy gilts at ‘issuance auctions' and they are subsequently traded in the markets because of the income they provide, together with a surety of repayment in the future, usually by the government issuing more bonds!

Now, if you had a surplus of stock to sell in a shop, you might be forced to discount your prices to ensure you sell out. With gilts, they have to do something similar, but in reverse; they have to make the interest rates the government is going to pay higher to ensure the gilts will sell.

We can envisage then that the huge increase in government borrowing will be agreed to at very attractive terms for the investor. The only real downside to gilts is that periods of high inflation can erode the value of the interest. E.G. Government pays, say 3% on a particular gilt, but if inflation was 4%, you are losing out. However, the government is committed to low inflation, and over the next year or two we might even see deflation or minus inflation rates.

Not surprisingly then when, when investors ask me about where to invest, I ask them ‘How much are you prepared to lose?' This soon focuses the mind on the realities of stock market investment, and as a result, gilts and similar assets figure strongly in recommendations. Generally speaking, investors like a good return, but they hate volatility.

To put this in context we can compare the last 5 years returns from shares and gilts.

The FTSE 100 index is 1.24% lower than it was 5 years ago, despite hitting near record highs a year ago.

‘Medium Gilts' however, are 24.79% higher.

Hare and tortoise spring to mind.

This weeks question then.

Why are gilts called gilts?

First correct answer wins a rather attractive blue paperclip.

John C. Cartlidge
Independent Financial Planner
Tel: 0151 336 6610
Email

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