How to invest in UK government bonds with an ETF

Gilt funds or gilt ETFs can represent an alternative to buying individual gilts, but it’s important to understand the differences.

| 7 min read

Rising interest rates have opened up opportunities for meaningful returns from UK government bonds or ‘gilts’. While these were an unattractive option when interest rates were rock bottom, they are now appealing to some investors as they offer a pre-determined return with low risk if held for their full term.

A gilt is a bond issued by the UK government to finance public spending. As a holder you get regular interest (known as the ‘coupon’) and the original amount lent repaid when the bond ‘matures’ at a set date. Individual gilts can be issued for any length of time from three months to 30 years, or even longer. Investors can hold on to them until they mature, or they can buy and sell them on the market, like company shares.

Government bonds are typically viewed as the ‘safest’ type of bond and gilts have a very high credit rating, reflecting the fact that interest and capital repayment is guaranteed by the UK government, which has never failed to make payments. However, the price of a gilt in the market tends to change over time, mostly in reaction to interest rates. If they go up, a gilt’s price usually falls, which means the available yield – the annual return an investor can expect for holding a gilt – rises. This also means you can make a capital loss on a gilt if you buy and then sell before maturity.

There’s more on how bonds in general, including gilts, work here.

What is a gilt fund?

Gilt funds or gilt ETFs can represent an alternative to buying individual gilts. There are several advantages in doing so.

You’ll be diversifying across lots of different gilts with different maturities, making it an ongoing investment rather than one that expires at a certain date. The minimum investment size is also much smaller. It’s also possible to buy and sell online, which isn’t normally possible with individual gilts, plus as an alternative you can easily access overseas government bonds too such as US treasuries.

Bond trackers and ETFs (Exchange-Traded Funds) can be issuer or geography specific, as well as broadly or narrowly focussed on maturity. For instance, some exclusively invest in shorter dated bonds (maturing in the next 12 months), others only the longer dated issues (maturing between 10 and 30 years into the future). The longer dated a bond the more sensitive it tends to be to changing interest rate expectations, so they can be volatile when things shift suddenly. There are also actively managed funds that invest in gilts, or other bonds more broadly, which aim to outperform a particular benchmark index.

Read more: Why funds are a great investment shortcut

Are gilt funds tax free?

Individual gilts are free from capital gains tax (CGT), which means you do not have to pay tax on any profit you make when you sell a gilt or it is redeemed. With many gilts trading below their redemption value they can be useful for higher and additional-rate taxpayers who pay CGT at 20%.

However, this capital gains tax advantage does not apply when they are held within an ETF or fund. If you make a capital gain outside a tax-efficient account, such as an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP), then tax may be payable. Funds also incur annual management charges and expenses, which detracts from returns, so if you are investing larger sums of money outside of a tax-efficient account then you could consider low yielding gilts that mainly provide capital return rather than income.

The interest from individual gilts and gilt funds or ETFs is also taxable when held outside an ISA or SIPP. If your interest from all sources exceeds the personal savings allowance in a tax year, and your overall income exceeds the income tax personal allowance, then you will have to pay tax on your interest returns from a gilt fund or ETF.

Are gilt funds safe?

Investing in gilts isn’t right for everyone. While gilts are as seen as ‘safe’ their returns are generally pedestrian compared with other areas such as the stock market over the long term. In addition, your capital is at risk, and they can suffer badly when interest rates suddenly rise, especially longer dated gilts.

This is what has happened in recent years as inflation ramped up much faster than widely expected and took longer to fall. However, from this juncture there are good arguments for holding bonds and gilts as part of a more secure part of a diversified portfolio, and the asset class stands to benefit from an environment where interest rates fall by more than widely anticipated.

Is it the right time to invest in gilt funds?

There could be some value in UK gilts presently if UK interest rates are cut faster than markets are pencilling in. Even if inflation remains sticky and the Bank of England keep rates high, gilts could still provide a respectable return given income yields above 4% across virtually all maturities. However, should inflation rebound and remain significantly above the bank’s 2% target (keeping interest rates high too) then gilts, and gilt funds, would likely struggle.

How to invest in gilt funds

You can invest in gilt funds and ETFs via an online investing platform such as Charles Stanley Direct. One example of a UK gilt ETF is Amundi UK Government Bond UCITS ETF, which is on our Preferred List of fund ideas for new investment.

The ETF is designed to replicate the total return of the FTSE Actuaries UK Conventional Gilts All Stocks Index, which is intended to reflect the breadth of the UK gilt market. Around 40% of the fund is in bonds with maturities of more than 15 years, so it will be highly sensitive to interest rate and inflation expectations. If these rise, then the capital value of the fund is at risk.

The ETF fully replicates the index by tracking approximately 40 gilts. It features competitive charges and, typically, small trading spreads. The index is rebalanced monthly, and income is distributed to investors on a six-monthly basis.

Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus.

Charles Stanley is not a tax adviser. Information contained in this article is based on our understanding of current HMRC legislation. Tax reliefs are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.

The value of investments can fall as well as rise. Investors may get back less than invested. Past performance is not a reliable guide to the future. This article is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Charles Stanley and Co. Limited is authorised and regulated by the Financial Conduct Authority.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Is your portfolio working hard enough for you?

If you are unsure of the level of risk you should be taking or which types of investments to consider, a consultation with a professional can help provide fresh insights going forward.

See more

More insights

Five tips for investing in gold, silver & other commodities
By Rob Morgan
Spokesperson & Chief Analyst
23 May 2024 | 7 min read
Investing in Japan: what’s the market outlook?
By Rob Morgan
Spokesperson & Chief Analyst
23 May 2024 | 11 min read
US market review: what are the prospects for investors?
By Rob Morgan
Spokesperson & Chief Analyst
07 May 2024 | 12 min read
April’s top performing funds
By Rob Morgan
Spokesperson & Chief Analyst
02 May 2024 | 11 min read