Why it's time to invest in gilts

Right now, gilts are offering returns not seen for fifteen years. This is good news for new investors looking to capture a high and secure income.

| 7 min read

What are gilts?

Gilts are UK Government bonds issued by HM Treasury to finance public spending and are listed on the stock market. To buyers of gilts, the government agrees to make timely interest payments and return the capital on the maturity date.

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 these payments on time and in full. They are typically issued at £100 - also known as the bond's par or face value - and the fixed cash payments (the rate of interest or “coupon”) are made every six months until the sum invested (the “principal”) is due to be paid back (the “maturity date”). Bonds can be issued for any length of time from three months to 30 years, or even longer.

Why invest in gilts now?

In July, the UK government issued a bond paying investors an annual return of 5.668% over two years. This marked the highest yield of any gilt sold since 2007 and we are now seeing the return of gilts as a viable investment vehicle that afford a high degree of security for portfolios and potentially tax-efficient returns compared to bank savings accounts.

Gilt yields are likely to remain high in the near term. There are few signs of the Bank of England reducing interest rates any time soon and rates may go higher still if inflation proves persistent. With yields at these levels, gilts now represent an alternative option for investors looking for a home for cash savings, with notable advantages over a conventional savings account.

At the moment, it is possible to buy bonds with relatively high yields compared to the past decade. Investors who are not likely to need to access their money at short notice, and who can withstand the daily fluctuations in bond prices until the bond matures, will be able to lock in these high yields.

Why are yields high today?

The Bank of England has raised interest rates 13 times since late 2021 in an effort to curb rising inflation, taking them from 0.1% to 5%. There is an inverse relationship between the level of interest rates and the market price of gilts. As interest rates rise, the returns offered by bonds issued in the past can become unattractive and the values (prices) of the bonds fall. As the value of the bond falls, it’s income as a percentage of its value (its “yield”) rises.

Higher interest rates have led to a dramatic fall in bond prices and the income they provide has risen.

This is good news for new investors looking to capture a high and secure income. Right now, gilts are offering returns not seen for fifteen years.

How long will they stay this high?

Shorter-dated bond yields are driven by central bank policy, while longer-dated bond yields reflect future economic health.

These higher rates are expected to slow the economy and drive down inflation. The expectation is that in the longer-term interest rates will have to fall again as the economy weakens. This is why longer-term bonds are offering lower yields. Today, short-dated government bonds offer a higher yield than longer dated government bonds, something called a yield curve inversion. This is the situation today, where two-year gilts are yielding around 1% more than 30-year gilts.

For investors, it means they can get a higher yield but tie up their money for a shorter period of time.

What level of returns are the offering?

Government bonds are quoted with a ‘yield to maturity’ (YTM) – this is the total return (capital and income) you can expect to receive if you hold onto the bond until it is due to be repaid. The YTM is calculated using the purchase price, coupon rate and time to maturity.

Some gilts offer attractive yields through high coupon rates, providing investors with a highly predictable contractual income. Other gilts with lower coupons trade at a discount to their face value. In these instances, high yields are driven by capital gains, which may be particularly useful for higher rate taxpayers (see below).

How can I take advantage of this opportunity?

Gilts can be bought from other investors before their maturity date on what is known as the “secondary market”. The prices of gilts in the secondary market will be influenced by several factors, including the level of interest rates and the time left to maturity.

Provided the UK government does not default, an investor will get back the principal amount on the maturity date. However, prices of gilts before the maturity date can vary and if you decided to sell the bonds before the maturity date, or needed to sell them due to unforeseen circumstances, you might get back less than you paid for them and realise a loss.

When can gilts be tax efficient?

Any capital gains on Gilts are exempt from capital gains tax: investors do not have to pay capital gains on any profits they make when they sell or redeem the gilt. This only applies to direct purchases (individual bonds holdings).

This has become a more valuable option this year as the CGT exemption – the amount of capital gains that can be made without being taxed – has been cut from £12,300 to £6,000. In practice, this is only an advantage when buying and selling gilts in the secondary market because investors that buy at £100 will redeem at £100 and therefore have no capital gain.

Please note: the tax benefits of holding bonds do not apply if you hold them through a bond fund, such as an ETF.

Gilts can be a good alternative to a savings account

When an investor buys a gilt, the coupon is locked in for the term of the bond. If the coupon is 5%, they can be assured that’s what they will receive. With a savings account, the bank may change the rate at any time, creating uncertainty.

Equally, savers are reliant on the creditworthiness of the bank, with the UK government only guaranteeing deposits up to £85,000. With a gilt, the whole amount is backed by the UK government.

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Charles Stanley is not a tax adviser. Information contained within this page is based on our understanding of current HMRC legislation. Tax reliefs and allowances 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.