Investment Committee Update: US Treasuries

Economic Commentary

One of the key changes we have made in 2018 has been the inclusion of United States government bonds to the Flying Colours portfolios.

The investment enhances the profile of our portfolios in several ways and I would like to share some of these with you.

Firstly, and most obviously, the US Treasury market is offering investors a superior yield than UK Government Bonds.

While UK Gilts are traditionally seen as the risk-free asset class for a UK investor – yields are currently sitting at very low levels. At the time of writing, a ten year gilt – a UK government security maturing in ten years’ time – is yielding 1.5%; this compares with a 3.0% yield from the equivalent ten year Treasury.

This matters, as with fixed income assets the starting yield is by far the most significant driver of future returns.

Secondly, and perhaps less obviously, is the lower risk from investing in US Treasuries. Here we are not referring to default risk; the risk of default from either bond is essentially zero. Instead we are referring to interest rate risk, or duration of the two markets.

The UK Government has been issuing debt with longer and longer maturities. This means for index investors like Flying Colours, holding a Gilt fund exposes us to greater and greater interest rate risk.

The iShares UK Gilts All Stocks Index Fund which we have chosen to invest in has an effective duration of 11.35 years. By contrast, the Vanguard US Government Bond Index fund has an effective duration of just 5.97 years.

Duration measures the sensitivity of the fund to changes in interest rates – the higher the duration, the greater its losses from rises in  interest rates.

This means the Vanguard fund is roughly half as sensitive to changes in interest rate rises compared to the Gilt tracker, and historic volatility is also around half that of the iShares fund. As a result, we see the move as a significant enhancement to our more cautious risk profiles.

Guy Myles
Chairman, Flying Colours Investment Committee

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