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In an often volatile and unpredictable world of investing, the allure of stability and steady returns is a much sought after characteristic by investors. Whilst most UK investors will be very familiar with Premium Bonds and other types of National Savings and Investments (NS&I’s), with these being issued and backed by the UK government, less widely understood are the benefits to be obtained from buying UK Gilts.
What is a Gilt?
If you think of NS&I’s as government backed investments aimed at retail investors, Gilts are issued by the United Kingdom Debt Management Office (DMO) and sold to institutional investors. However, these can be also bought and sold on the secondary market by ordinary retail investors and if you have a pension pot and are close to retirement, the chances are you will already be holding some within the funds held in the portfolio.
What are the Advantages of Investing in UK Gilts?
Investing in Gilts can present several compelling advantages that make them an attractive choice for investors seeking stability and reliable income, as well as the potential for higher net of tax returns versus cash deposits – particularly for higher or additional rate taxpayers. They can also offer excellent portfolio diversification, especially for a portfolio that is otherwise reliant on stocks and shares: Here are some of the key benefits:
Safety and Stability
Gilts are backed by the full faith and credit of the UK government, making them one of the safest investments in the world. Unlike stock market investments, which can be volatile and subject to market fluctuations, Gilts offer a stable and predictable source of income. This safety net is particularly appealing to conservative investors who want an alternative to cash deposits or those nearing retirement who are looking to prioritise capital preservation over high returns.
Regular Income
One of the primary attractions of UK Gilts is the steady stream of income they provide through interest payments, known as coupon payments. These payments are typically made semi-annually and are fixed at the time of issuance, providing investors with a predictable source of cash flow. For retirees or those seeking passive income, Gilts can be an essential component of their investment strategy, offering a reliable source of income to meet living expenses or supplement other retirement income streams.
Liquidity
UK Gilts are highly liquid investments, meaning they can be easily bought or sold in the secondary market. This liquidity provides investors with the flexibility to adjust their portfolios in response to changing market conditions or personal financial goals. Whether you need to raise cash quickly or take advantage of an investment opportunity, Gilts offer the liquidity needed to execute transactions efficiently.
Diversification
Including UK Gilts in a diversified investment portfolio can help mitigate overall risk. While stocks and other riskier assets may experience shocks during economic downturns, Gilts tend to perform well in times of market turbulence. Their inverse correlation with equities means that they can act as a hedge against stock market volatility, providing a level of stability to the portfolio.
Tax Efficiency
UK Gilts offer tax advantages that can enhance overall investment returns. Whilst income is taxed the same as bank deposits – unless held in a tax-advantaged account such as an ISA or SIPP – any gains from holding Gilts are exempt from Capital Gains Tax and so this can result in higher net of tax returns than could be achieved from cash deposits for example.
How Safe are Gilts?
In finance models, UK Gilts are used to calculate the risk-free rate of return – and so are considered a safer counterparty than a bank account for example. The UK government has never failed to repay domestically issued debt and so your capital is as secure as possible.
Unlike with savings deposits, there is no £85,000 cap on Financial Services Compensation Scheme (FSCS) protection. When buying Gilts, you could invest £10M in a single issue, without needing to spread your savings around – as would be required if you wanted to enjoy the equivalent protection as someone investing £85,000 in a UK savings account. Investing in Gilts is deemed as safe as putting your money into National Savings and Investments – such as Premium Bonds – which are also 100% guaranteed by the government.
However, as with all investments, the value of your portfolio can go up and down, especially if you are holding longer-dated Gilts. Gilts are only guaranteed to pay out at face value at maturity; if you needed to sell a Gilt early, the amount you would receive would be determined by prevailing market conditions.
For this reason, it is very important to invest in a portfolio of Gilts with a range of maturities and/or that have been specially selected to meet your individual goals and objectives.
How do Gilts Work?
Gilts are normally issued at a price of £100, which is known as the par value. Each gilt will state the interest rate payable and the maturity date for when the Gilt will mature, and the par value will be repaid in full.
Gilts pay usually pay interest every six months, and this is given as a percentage of that £100, which is known as a coupon. This is the amount of income you get each year.
For example: if you bought £100,000 of Gilts when issued at £100 per unit and that pays a coupon of 4%, you would receive £4,000 of interest payments every year.
If you kept the Gilt until the end of its term, you would receive your £100,000 back at maturity.
Do I Have to Hold a Gilt Until it Matures?
No. As Gilts are traded, they can be bought and sold – either in full or part – during normal market hours. This can be above (or below) the price at which they were issued at. The amount of income you will receive is based on what you paid for the Gilt and is known as the running yield.
For example: if a Gilt paying 4% is purchased when it is trading at £90, the actual rate of interest you will receive from the purchase of £100,000 of units is 4.44% or £4,440 per annum.
Gilts can be sold, and your capital made available within just a few days, whereas many higher-rate interest cash accounts tie your money up.
What Affects Gilt Prices?
When interest rates change, the price of a Gilt tends to change too. When the base interest rate rises, the price of Gilts tends to fall. That’s because the interest on offer won’t now look as attractive as it did when rates were lower, so the market price of the Gilt needs to adjust (move lower) to compensate for this.
When higher interest rates cause bond prices to fall, this also means the yield increases – i.e. what you get as a percentage of the price you paid. That means the price and the yield on a bond move inversely – as one rises, the other falls and vice versa.
Higher Interest Rates Have Created
Excellent Buying Opportunities
The Bank of England began raising interest rates in December 2021 until they reached their current level of 5.25% since July 2023. These constant rises saw the worst-ever recorded drop in the fixed interest market. The price of Gilts fell so far that in many cases, their market value is still well below their maturity value.
Gilts can provide an attractive return without taking on the additional risk that investing in wider corporate bonds or equity markets does.
Short-Dated Vs Long-Dated gilts: Different
Gilts for Different Goals
Short-dated Gilts are issues that are due to mature relatively soon, and this could be classed as anything from a couple of months to 5 years from now. Short-dated Gilts are an excellent, highly tax-efficient alternative for higher or additional rate taxpayers – or indeed anyone with significant cash savings that has concerns over the £85,000 cap provided by FSCS protection. As well as individuals, this could also include businesses. Businesses often hold much higher sums of cash and yet receive lower interest rates on their deposits.
Medium-dated Gilts would be considered 5-15 years. At the longer end of the spectrum, there are issues that won’t mature for as much 50 years! Medium and long-dated Gilts are ideal if you want to secure a guaranteed income for a long period or want to target capital gains if interest rates move lower in the future. They can also offer excellent portfolio diversification and a hedge against volatility, especially where you have an existing portfolio that is heavily weighted to UK or global shares.
Whether you buy a short or long-dated Gilt, the capital security of your money is effectively the same (i.e. backed by HM Treasury), however the underlying price of the Gilt should you wish to sell it (something which is very relevant if buying a long-term Gilt as it is very unlikely you would want to hold onto it for 50 years!) will be very sensitive to interest rate movements.
Duration and Price Sensitivity
A simple way to understand this concept is to compare the price movement of Gilts to the swing of a pendulum. Small movements in the swing of the pendulum at the top will translate into ever increasing movements the further you reach to the bottom.
When interest rates move up and down, the underlying price of the Gilt will also move – and the extent of the movement being determined by how long dated the Gilt is.
Short-dated Gilts near to the top of the pendulum will move very little as they are shortly due to mature at their face value of £100. However, if we move further down the pendulum, these longer dated Gilts will be increasingly sensitive to interest rates movements.
Risk or Opportunity?
It should be apparent now that buying long-dated Gilts when interest rates are low can be a very bad idea– especially if you don’t plan on holding them until they mature! Conversely, buying long-dated gilts when interest rates are at or close to peak levels, can provide an excellent source of secure income that can be locked in for a very long time – unlike a deposit account that is normally limited to a maximum of 5 years. Fixed deposits usually have conditions attached to them which can range from not being able to access your money before the end of the term or with penalties that would see you lose some or all your interest if cashed in early.
Furthermore, if you think interest rates might move lower in the future, then buying long-dated Gilts now could offer the potential for attractive capital gains (in addition to the guaranteed income) if or when interest rates move lower, and you still own them.
How are Gilts Taxed?
Whilst the income that Gilts pay will be treated the same as interest from bank deposits, any gains from the increase in value of the underlying price you pay for the Gilts is exempt from capital gains tax (CGT). All Gilts – short or long-dated – will redeem at par value of £100 on their maturity date.
For example, a Gilt with a current price of £95 that will mature in 12 months’ time for £100, represents a return of 5.26% and as the gain is CGT exempt, this is a net return. As a higher rate taxpayer, you would need an interest rate of 8.75% to achieve a comparable return.
You also won’t pay any tax on Gilts if you hold them in a tax-efficient wrapper, such as an ISA or a Self-Invested Personal Pension (SIPP).
Investing in Direct Gilts Vs Gilt Funds
There are lots of Gilt funds available to buy depending on your objectives. However, there are several downsides to this method versus holding them individually:
- You can’t control the exact maturity of the Gilts you are investing in and so doesn’t offer the same certainty of returns for the period you plan to hold them. When buying them directly, a range of Gilts can be purchased with different maturities that match you goals and objectives.
- The gains from funds are not free from capital gains tax, which might not be a concern if held in a SIPP or an ISA. But if like many people, you are buying Gilts to achieve a higher net return versus cash held on deposit, a fund isn’t going to achieve the same goal.
Gilts as a Liability Planning Tool
As Gilts have known returns at maturity, a Gilt maturity ladder can be created to coincide with that are due, with multiple Gilts maturing to match the liabilities as they become payable. Examples of this could be when a liability such as school fees or a mortgage is due.
By investing in a portfolio of Gilts to create a maturity ladder, you can be certain that your money is working hard for you and will deliver right when you need it to.
By investing in a Gilt portfolio with First Equitable, we can access a range of directly held gilts, rather than having to invest via gilt funds. This allows us to create a bespoke portfolio of Gilts, where we can select the issues that best match your goals and objectives – and at a competitive price.
Are UK Gilts Suitable for Me?
You could benefit from investing in the First Equitable Gilt Portfolio service if you:
- Have a minimum of £100,000 available to invest.
- Are in position to leave your money invested for a least 2 years, but possibly for longer depending on what you want to achieve.
And one or more of the following apply:
- You are a higher or additional rate taxpayer and want to achieve a higher net return from your savings.
- You have used up your ISA allowances and are looking for tax-efficient ways to invest.
- You are a business owner and want to a better return from your cash reserves.
- You are concerned that the FSCS cap of £85,000 does not provide enough protection or peace of mind for your savings.
- You want to lock in current high interest rates to provide a regular income.
- You think interest rates may move lower in the future and want to target tax-free capital gains should that happen.
- You have an investment portfolio or pension that is heavily invested in stocks and shares and want to learn how Gilts can provide a hedge against portfolio volatility.
Please download our Guide to Investing in UK Gilts for more information. You can also complete our Contact Form if you want to speak with an adviser.
