Milburn says the key reason to own gilts right now is that in the event of a recession, they will rise in price terms.
But he adds that if one is trying to understand whether gilts are cheaply priced, “one should think about it like this: a 10-year bond should compensate you for inflation, and central banks target 2 per cent inflation, so you should be getting 2 per cent as a yield, then you need to be compensated for the real level of growth in the economy, which is between 1 per cent and 1.5 per cent, so that takes it to 3.5 per cent yield or so, and finally, because it is an investment where you won’t get your capital back for 10 years so you need to be compensated for this.
"That is called the term premium, and usually its about 0.5 per cent. So all in all, the long run yield for a 10-year bond should be around 4 per cent.
"At the moment it’s about 4.5 per cent, so it isn’t far off the long-term number, but we think with inflation coming down and government risk diminished, gilts are an attractive investment now.”
David Thorpe is investment editor of FTAdviser
