October 2022

Over the last three weeks, the terms “Gilt” and “Yield” have seemingly been ever-present in news bulletins. Following the announcement of the Government Growth Plan on 23^rd September, Gilts have come under pressure, which in turn forced the Bank of England into a temporary position whereby they purchased Gilts, in a move designed to stabilise the market. Let’s go back to basics and look at the importance of Gilts to the wider economy.

What is a Gilt

A Gilt is a loan note issued by the UK Government, who use the money raised by the sale of Gilts to fund public spending. Gilts are issued by HM Treasury and listed on the London Stock Exchange. The term “Gilt” or “Gilt-edged security” is derived from the fact that the British Government has never failed to make interest or capital repayments on Gilts as they fall due. The first Gilt was issued in 1694, to help finance the war against France, and raised a total of £1.2m. By way of contrast, the size of the Gilt market in 2021 topped £2 trillion.

The UK Government is not unique in raising funds in this manner. Most Governments issue loan notes in one form or another. The US issues Treasury Bonds, Germany issues Bunds, and other major nations, such as France, Italy, Canada and Australia also finance public spending in this manner.

Conventional and Index Linked

There are two different types of Gilts listed on the London Stock Exchange. Conventional Gilts comprise around 75% of the Gilt market, and all have two common elements. Firstly, they pay a “coupon” or fixed interest payment, each six months. Secondly, the Gilt has a redemption date, upon which the principal of the Gilt is repaid. This is typically a fixed price of £100.

The remaining 25% of the Gilt market is made up of Index Linked Gilts. These have a redemption date, in the same manner as Conventional Gilts; however, the coupon payments, and the principal value at redemption, are adjusted in line with the Retail Price Index (RPI). This means that the redemption value, and the interest payments, keep in line with inflation.

Common Factors

Whilst Gilts have a redemption date, the fact that Gilts are traded securities will mean that the price will fluctuate over time. Gilt market sentiment is often dictated by prevailing interest rates, and as we have seen over recent weeks, how the market views Government economic policy.

As interest rates rise, this increases the attractiveness of overnight money on deposit, and therefore makes a Gilt look less attractive. The opposite is true, as Gilts generally look more attractive when interest rates are falling. Furthermore, in the situation when interest rates are rising, any new Gilts that are issued will need to offer a higher coupon to attract buyers. This tends to lower demand for existing Gilts which may well offer lower coupons.

The time remaining until a Gilt reaches the stated redemption date will also influence Gilt prices. When a Gilt heads closer to its maturity date, the value of the Gilt will move towards the Gilt’s initial face value.

Finally, inflation can impact on whether Gilts are in demand. Higher inflation, as we have seen over recent months, will reduce the purchasing power of a Gilt’s face value and coupon payments.

How yields are calculated

Gilt yields are often quoted by market participants, rather than Gilt prices, as the yield offers  a reflection of the cost of borrowing. The running Gilt yield is calculated by dividing the annual coupon by the current price. For example, if a 5% Gilt is currently priced at £90, the yield is 5.55%. Adding the redemption price into the equation can give an indication of the total return a Gilt holder will achieve if the Gilt is held to redemption. Take the same example of the 5% Gilt, currently priced at £90. Assuming this redeems at £100, then the buyer would also benefit from a £10 capital uplift per Gilt held, to redemption.

Implications for other Bond markets

It is important to note that movements in Gilt markets affect the attractiveness of Corporate Bonds. This is due to the fact that Corporate Bonds tend to trade using a “spread” over the corresponding Gilt, which indicates a risk premium that the holder of the Bond is willing to accept for holding a Bond issued by a company, rather than a Gilt issued by the Government.

Why Gilt Yields matter – mortgage rates and public finances

As market confidence in Government economic policy has ebbed since the Growth Plan was announced, Gilt yields have generally been rising. The Bank of England programme to purchase Gilts stabilised the market a little, although concerns remain over the prospects for Gilts in the short term.

Yields are of importance to the mortgage market, as they affect so-called “swap” rates, which financial institutions pay to other institutions, to acquire funding for future lending. In simple terms, swap rates are a best guess as to where interest rates will be in the future, and tend to move in tandem with Gilt yields.

As Gilt yields rise, any additional Government borrowing will need to offer higher coupons, to ensure there are sufficient buyers for the Gilt issued. Furthermore, as Gilts reach maturity, the Government needs to roll over the borrowing into new Gilts, which again are likely to be at higher interest rates. This increases the interest bill paid by the Government and places further pressure on public finances. For this reason, the Government will want to ensure Gilt yields are brought back under control as quickly as possible.

Likewise, those with a fixed rate mortgage that is due to mature will be well advised to keep a close eye on Gilt yields as an indication of the direction of travel for mortgage rates in the near term.

Where next for Gilts?

Whilst some details of the change in Government policy have already been announced, market participants will still look to the 31^st October for full details of the Budget review. The market is likely to be quick to jump on any perceived weakness in Government messaging, following the replacement of Kwasi Kwarteng with Jeremy Hunt as Chancellor. Shortly after the 31^st October statement, both the US Federal Reserve and Bank of England will announce interest rate decisions on 2^nd and 3^rd November respectively. This will, therefore, be a period when further volatility in the Gilt market is likely. At FAS, we will, of course, continue to monitor events closely.

If you would like to discuss the above further, then contact one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

The UK Housing Market has seemingly defied gravity over recent years, shrugging off the economic effects of Brexit and the Covid-19 pandemic. For those who have suggested previously that prices may have peaked, there have been a number of false dawns. However, recent market data, together with the higher costs of living and the impact of mortgage rate hikes, may well combine to finally curb house price inflation.

The latest Halifax House Price data, released on 7^th October, showed that house prices decreased marginally in September, with a -0.1% month on month fall. Whilst not newsworthy on its’ own, perhaps of more interest was the news that the annualised rate of growth has now fallen in three successive months. Nationwide, who also publish monthly house price data, reported flat prices on the month and a further fall in the annualised rate.

Cost pressures

We are not surprised to see price growth slow, as the higher costs facing households begin to bite. Despite Government support which has capped the unit rates for Gas and Electricity domestic supplies for the next two years, household bills have still risen substantially from where they were earlier in the year. Food price inflation has also impacted on household budgets, and whilst petrol prices at the pump have fallen over recent weeks, they remain elevated from a year ago.

Whilst household outgoings have increased due to the cost of living, and caused some pain to household finances, the recent turmoil in the mortgage market is likely to have a bigger impact over coming months. Fixed mortgage rates have been climbing sharply since the UK mini-budget announcement on 23^rd September, the result of which has seen the yields on Government Bonds (Gilts) rise sharply, as markets reacted negatively to the announcements. This led to Bank of England intervention to stabilise the Gilt market by temporarily buying Bonds. Given the uncertainty, mortgage lenders raced to pull fixed rate mortgage deals at record pace, with new deals being released at sharply higher rates, as the cost of securing funding has now increased.

Mortgage hikes

To put this in context, prior to the Chancellor’s speech, the average two-year fixed rate mortgage was priced at 4.74%, but has now risen to more than 6% at the time of writing, the highest level since 2008. In stark contrast, the average two-year fixed rate mortgage was just 2.34% at the end of 2021. In monetary terms, taking out a £200,000 repayment mortgage over 25 years in December 2021, at the average two-year fixed rate of 2.34%, would have resulted in monthly mortgage payments of £881 per month fixed for the first two years. The same repayment mortgage taken out with two-year fixed rates at 6%, would result in an increase in monthly payment to £1,289 per month for the first two years.

For those borrowers on fixed rate deals that are shortly coming to an end, the new rates on offer are likely to come as a shock. The higher rates will also affect first time buyers, who will find affordability stretched further. The effect on the mortgage market is highly likely to negate the Stamp Duty changes announced in the Mini-Budget, which increased the residential nil-rate band from £125,000 to £250,000 for all purchasers, and from £300,000 to £425,000 for first-time buyers. Without the turmoil in the mortgage market, the permanent reductions in Stamp Duty may well have continued to support prices.

The wider impact

With homeowners being hit from all sides, a sharp slowdown in the housing market is now highly likely. This may well have wider economic consequences, as perceived strength in the housing market is closely linked to consumer confidence. As homeowners see house prices rise, they generally feel better off and more confident to spend. The reverse is also true, and for some who are over-leveraged, some homeowners risk holding a larger mortgage than the value of their home.

Housing transactions may also slow, which will affect many sectors of the economy. Each Property transaction completed will provide business for Removals and Storage firms, Solicitors, Surveyors, Estate Agents, together with spending and renovations undertaken by new householders. This may also have a knock-on effect on unemployment. The Home Builders Federation suggest that over 11,500 jobs are supported by housing transactions alone.

Reasons to be positive?

For those remaining positive about house prices in the longer term, supply side constraints remain. The Office for National Statistics (ONS) forecast the number of households in the UK will increase by 1.6m over the next 10 years, whilst the current rate of house construction in the UK is running at levels that falls short of the amount of new homes that will be needed.

It has also been suggested that landlords who are not keen on selling up may well be looking to increase rents, which in turn could lead to renters looking to purchase, in particular if prices fall by an appreciable amount.

Where does this leave Property investors?

Buy-to-let landlords have enjoyed the benefits of rampant growth in house prices, together with rental income, over recent years. However, those who are leveraged with Buy-to-Let mortgages may begin to see a squeeze on rental margins, which landlords may not be able to pass on to tenants.

From a financial planning perspective, residential property assets remain a valid part of any sensible diversified investment approach. With house prices likely to come under pressure, the risk of holding residential property as an investment has increased. This is further justification for landlords to look closely at the returns they are achieving on their property investments, and consider whether they need to adjust their overall strategy.

If you would like to discuss the above further, then contact one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

We would all like to think that we are able to manage our affairs successfully, and will continue to be able to do so in the future. However, an increasing number of people are affected by illnesses such as Alzheimer’s or Dementia, which can mean that individuals are no longer able to make decisions for themselves.

According to Alzheimer’s Research UK, almost 950,000 people in the UK are living with Dementia,  with this number projected to rise to 1.6 million people by 2040. A person’s risk of developing Dementia is 1 in 14 over the age of 65; however, this illness sadly affects younger people too, with over 42,000 people under the age of 65 being diagnosed with Dementia.

These very sad statistics underline how important it is to consider what would happen if you lost capacity to manage your affairs. Setting up a Lasting Power of Attorney (LPA) is straightforward and can make sure your loved ones can make the important decisions about your health and your financial wealth on your behalf, should you become incapacitated through ill health or accident.

What is an LPA?

An LPA is a legal document that lets you appoint someone you trust to make decisions on your behalf, should you become unable to make those decisions for yourself in the future. There are two different types of LPA, one covering Property & Affairs (e.g. property, investments and assets) and Health & Welfare (which covers health care and medical treatment).

You can choose to set up one or both types of LPA, and you can nominate the same person or elect to have different attorneys for each. Preparing an LPA doesn’t mean that you instantly lose control of the decisions that affect you. For the Property & Affairs LPA, you can be specific about when the attorney can take control when preparing the LPA, and in respect of the Health & Welfare LPA, this can only be used once capacity to make decisions has been lost.

All LPAs must be registered at the Office of the Public Guardian, which is the government body responsible for the registration of LPAs before they can be used.

Who to appoint as your attorney

Choosing the right attorney or attorneys is an important decision to reach. You can nominate anyone to be your attorney, provided they are 18 years old or older, and are not bankrupt.

The person, or people, you choose needs to be someone that you trust to make decisions for you, and will be able to act responsibly and in your best interests.

The risk of not preparing an LPA

If you lose mental capacity and don’t have an LPA arranged, this can leave loved ones with significant worry, and could potentially have ramifications for the individual’s personal finances.

If an LPA has not been prepared, and mental capacity is lost, an application will need to be made to the Court of Protection, for an individual to become your appointed ‘deputy’. This deputy will then make financial decisions on your behalf. The Court has the final say as to who is appointed, and this may not align with your wishes.

The process of making a Court application is long-winded, with applications taking many months to be heard and then approved. This could lead to significant issues for ongoing financial transactions, such as investment management, or the purchase or sale of a property. Directors and Business owners are at particular risk, as loss of capacity could lead to the situation where no individual is authorised to run the business.

Furthermore, using a Solicitor to support a Court Deputyship application can lead to expensive costs, that could be avoided by preparing an LPA in advance.

LPAs and Investment Advice

When an individual loses capacity, attorneys will often seek independent financial advice in respect of assets held by the donor of the power. For example, we are often asked to provide investment advice to attorneys where the donor has moved into long term care, and their property has been sold, leaving a cash sum upon which investment advice is needed.

It is important to recognise that an attorney appointed by an LPA is generally not permitted to delegate responsibility to another individual, without express permission by the Court of Protection. This has an impact when an individual holds investments that are managed under an existing Discretionary Management agreement, and then loses capacity to manage their affairs.

This can be overcome by inserting specific wording in the LPA document when it is prepared, which provides express permission to delegate investment management decisions to an existing or new discretionary investment manager. The view of the Court has, however, changed over the course of the last year, and it appears the Court is taking a more practical view when these situations arise.

Don’t leave it too late

Given the sad prevalence of cognitive decline in the population, we can’t stress enough the importance of preparing an LPA document. Most people appreciate the importance of making a Will to deal with affairs and assets on death, but perhaps don’t place the same emphasis on preparing an LPA. Failing to take this step can lead to unnecessary stress for loved ones, and potentially leave the individual exposed to significant risks in respect of investments, property or business assets. We strongly recommend that all individuals consider preparing an LPA, either in conjunction with a review of their existing Will, or separately.

How we can help attorneys

Whilst the focus is often placed on the importance of ensuring an LPA is in place, attorneys appointed under an LPA can often find themselves thrown in at the deep end when trying to manage the finances of the donor. At FAS, we have considerable experience in assisting attorneys to understand assets held by the donor of the power, and can provide independent advice on existing investments, or how best to invest cash funds held by the donor. Give one of our experienced Advisers a call if you require assistance.

If you would like to discuss the above further, then contact one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.