The UK base interest rate has stayed steady at 5.25%.
But as interest rates have increased over this year, interest in government bonds (gilts) has been going up. That’s because yields of gilts have been climbing alongside interest rate rises. As of Friday 15 September, you could get 4.67% on gilts that have one year until they’re redeemed.
This is sparking the interest of many investors. But why? And what are HL clients buying?
This article has been written independently of our investment research team to offer some inspiration, but isn't personal advice or a guide on how or where to invest.
You should choose investments based on your own objectives and attitude to risk. If you're not sure whether an investment is right for you, ask for financial advice.
All investments and any income from them can fall as well as rise in value, so you could get back less than you invest.
Investing in individual gilts isn’t right for everyone, you should only invest in gilts as part of a diversified portfolio.
What is a gilt?
A gilt is a UK government bond. When you buy one, you’re lending money to the UK government in return for regular interest and you get the original amount lent to them back when the bond matures.
Just like with other bonds, the borrower (in this case the UK government) promises to pay back the loan at a fixed date and to pay interest in the meantime.
When interest rates change, the price of a gilt tends to change too – if interest rates go up, gilt prices usually fall, but that means the yield then goes up.
Government bonds are typically viewed as the ‘safest’ form of bond. That’s because a government usually has control of its currency, so can print more money to pay back investors if it needs to.
What gilts did HL clients buy in August 2023?
Most bought gilts (numbers of buys, minus sales):
- Treasury 0.25% 31/01/2025
- Treasury 0.125% 31/01/2024
- Treasury 0.5% 22/10/2061
- Treasury 0.125% 30/01/2026
- Treasury 5% 07/03/2025
- Treasury 0.125% 31/01/2028
- Treasury 6% 07/12/2028
- Treasury 3.5% 22/10/2025
- Treasury 1% 22/04/2024
- Treasury 2.75% 07/09/2024
Information correct as at 1 September 2023.
Why are gilts becoming more popular?
There’s always a place for bonds and gilts in a well-diversified portfolio. And thanks to rising interest rates, more investors have started to sit up and take notice of them again.
When interest rates rise, gilt prices tend to fall. And that’s when things get really interesting.
If a gilt’s price falls, its income yield rises. And if the price of a gilt falls below its par value (£100), you’ll get a government-backed capital return if you hold it until its maturity date. Though a capital loss is still possible if you sell before maturity, or if the government defaults.
There’s also a big tax benefit of investing in gilts.
The tax advantage of holding gilts
There are two types of return when you invest in gilts. The income and any capital gain. Each element is taxed differently for private investors.
Interest paid by a gilt is taxed as income.
Any capital gains, however, are tax free. If you sell at a capital loss, this can’t be used to offset other gains. You also don’t pay any stamp duty or stamp duty reserve tax when you buy a gilt.
If you hold gilts in an ISA or Self-Invested Personal Pension (SIPP), you won’t pay any UK income or capital gains tax on them at all.
Remember though, tax rules can change, and benefits depend on your individual circumstances.
Here’s an example based on buying 105 units of a gilt trading at £95.15 each for a cost of £10,000, with a nominal interest rate of 2% and set to mature in 2025. In two years, the government will repay the capital at £100 per unit meaning you would get:
| Income return | Capital return | Total return |
|---|---|---|
| £420 | £500 | £920 |
| 4.2% | 5.0% | 9.2% |
So, for this gilt, that works out at over 4.5% annual return, excluding any dealing commission. More than half of this return comes from capital gains rather than income.
Of course, each gilt is different and investors could get a different ratio between income and capital returns.
What should you be aware of?
You’ll pay dealing commission to buy a bond or gilt, and if you decide to sell it before it redeems, this will eat into your returns.
With us, this starts from £11.95 for online trades and is 1% (minimum £20, maximum £50) if you trade over the phone or by post.
You’ll also need to pay the accrued interest to the seller of the gilt as part of the trade. This is the amount of interest the gilt is determined to have built up in between the payment dates for income.
This is standard practice in the bond market and strikes a fair balance between buyers and sellers. It also neatly helps differentiate between cash flows from income and those from capital gains.
What is ‘clean’ and ‘dirty’ pricing?
When you’re buying a gilt, it’s worth noting the difference between what’s known as the ‘clean’ and ‘dirty’ price.
The clean price is the price of a bond not including any accrued interest. This is the price that’s normally quoted on our website.
The ‘dirty price’ is the price of a bond that includes accrued interest between coupon payments.
If you buy a bond immediately after issue or the most recent coupon, the clean and dirty prices will be the same.
However, if you buy partway through a coupon period (they’re typically paid twice a year), you’ll need to account for adjustments that reflect income accrued to the bond. This means the actual price you pay will include accrued interest and the cost of the bond.
In practice, once you’ve bought the gilt, it will reflect as a ‘loss’ on your account – this is simply because the accrued interest was not reflected in the value shown.
You could get better investment performance
While gilts are as ‘safe’ as you can get when investing in bonds, they don’t always offer the highest returns for that very reason.
Inflation is currently at 6.7%. As you can see from the latest UK gilt yields on offer, it’s not enough to beat inflation and give you a ‘real’ return – but that doesn’t mean gilts should be ignored.
Gilts can play a valuable role in diversifying any investment portfolio and shouldn’t be overlooked.
FIND OUT MORE ABOUT DIVERSIFICATION
How to invest in gilts
You can buy individual gilts with us and hold them within any of our investment accounts.
While you can buy and sell lots of them online, you’ll need to trade some of them over the phone by calling our dealers.
FIND OUT MORE INCLUDING CHARGES
If you’re looking to hold gilts as part of a smaller portfolio, funds can be a great way to do it.
You can start investing in a fund from £25 a month as a direct debit or £100 as a lump sum.
Though unlike holding gilts directly, funds that invest in gilts can be subject to capital gains tax.