Hot Stocks: Tesco's RPI-linked bond tops the 'buys'

An excellent diversifier, but equity income with carefully chosen blue chips still very attractive. Sainsbury, Vodafone, BT, Glaxo, Shell, HSBC, etc. but classical portfolio structure, where income is essential, would suggest not putting capital at undue risk. But as part of a calorie controlled diet....

www.pensionsmanager.blogspot.com for more ramblings

The bond doesn't offer "1% above the RPI measure of inflation.", it offers 1% indexed by the RPI.

So inflation at 5% would be interest of 1.05% in the first year, not 6%. I wonder if some buyers have failed to grasp this?

In that scenario, the redemption value is where the kick comes.

In order to get your money back you would need to sell the bond or hold for the full 8 years. The capital value of the bond at any time during the 8 year term will be dependent on what someone is willing to buy the bond for. If interest rates rise or inflation falls the demand for, and therefore value of, the bond will be lower.

The income during the term starts at 1% and changes in line with inflation. The treasury document for medium term forecasts (averaged from a range of independent forecasts) shows RPI as follows:

2012 – 3.3%

2013 – 2.6%

2014 – 3.2%

2015 – 3.6%

So assuming RPI remains constant after 2015, then the following income payments would be made

2012 – 1.00%

2013 – 1.03%

2014 – 1.06%

2015 – 1.09%

2016 – 1.13%

2017 – 1.16%

2018 – 1.20%

2019 – 1.24%

Therefore holding until maturity the coupon/income from the bond equates to 8.91%. Further to this, if held until maturity, the capital would have increased by 30.16%. Giving a total return of 39.06%.

A five year fixed rate bond could offer 4.7% interest per annum. If this was available for the full 8 years it would return (after basic rate tax)39.40%. Therefore not making the TESCO bond look that attractive given that locking it away in a savings account offers a potentially similar return.

Stuart - thank you a very helpful analysis.

This bond is very dicey and unpredictable as to its final returns. Interest rates have been made pathetic through government policies and at present I don't know if there is any way savings can be protected.

The fact that a fund giving only 1% real return is so popular, shows how desperate our economic situation is and how our small savers are milked to finance the banks and bankers with their obscene bonuses..

. But i do not think for a moment this will stop the well heeled 1% looking around for the next war to be fought by the other 99% of paupers. This insanity will only stop when we re reduced to 3rd word status, which will not be very long now. Hopefully the Chinese and Indians will want English gardeners and chauffeurs.

why mess with this bond, buy inndex linked gov. bonds directly or via etfs.

Govt. index linked bonds (UK) are in negative real yield territory at the moment due to 'safe haven' status and high demand from pension schemes, insurers, etc. Corporate index linked bonds are more risky and have to offer a better deal. As the capital and coupon rise by RPI and you getting a 1% coupon, that is better than ILGs at the moment, but riskier of course.