Bond Market Review – UK Government Bond Volatility

UK government bonds (gilts) have been volatile since the start of the war in Iran, with yields increasing. We look at the reasons for this as well as performance of bond funds on our Wealth Shortlist.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. All investments can fall as well as rise in value, so you could get back less than you invest. Yields are variable and not a reliable indicator of future income. Past performance also isn’t a guide to the future.

Gilts

Gilts have been in the headlines a lot recently. And this is no surprise given the rise in yields, and corresponding fall in prices since the start of the war in Iran. Yields have hit multi-decade highs several times in recent months.

Gilt yields represent the annual return investors can expect from a gilt if held until it matures. It can be made up of income in the form of interest payments (coupons) and capital gains in the form of price rises.

There are a couple of reasons for the increase in yields. The biggest is the impact of the war in Iran on oil prices and in turn, inflation expectations.

With higher inflation expected the potential for the Bank of England (BoE) to cut interest rates has fallen. Before the beginning of the conflict, markets were expecting two rate cuts in 2026. Now these expectations have shifted to three quarter-point rate rises. And bond yields have increased in response to these expectations.

At the same time, political instability in the UK has added further upward pressure on gilt yields. This is because there’s speculation that any new Labour leader could bring the previously agreed UK fiscal rules into question.

Investors don’t like uncertainty. And bond investors don’t want the UK to increase future spending due to concerns about the long-term affordability of existing government debt. Bond markets have therefore responded by demanding higher yields.

It means gilt prices have been volatile. It’s also meant losses. But the losses have been very different for investors who own gilts that mature within the next few years, compared to those with gilts that mature decades into the future.

The 5-year, 10-year and 30-year gilt yields increased by 0.86%, 0.78% and 0.68% respectively, from the end of February to the end of April.

But returns over the same period were quite different, with the FTSE Actuaries UK Conventional Gilts up to 5 years index falling 1.23%*, whereas the FTSE Actuaries UK Conventional Gilts over 15 years index lost 8.97%. This is an extremely short period to consider performance over, but it shows how much more stable prices can be for shorter-dated bonds compared to longer-dated ones.

It’s important to remember that price changes only impact returns if you sell the gilt before it matures. There’s no impact for investors who buy gilts directly and hold them until they mature, as the returns on conventional gilts are normally fixed.

While it’s been volatile, it could be an interesting time to invest with current yields at levels not seen for many years. That said, it’s possible yields could continue to rise in the short term.

How have bonds performed over the last 12 months?

Performance has been different for different parts of the bond market over the last 12 months.

Higher-risk high yield bonds have provided the highest returns, while UK government bonds have provided the lowest. This is largely because of the higher yields those bonds offer. Companies with a higher risk of defaulting on their bond payments have to offer higher returns to investors to take that risk, especially compared to the UK government.

The IA £ Strategic Bond sector returns have been in the middle of the range over time, as you’d expect given funds in that sector can invest in all types of bonds. This is the potential benefit of investing in those funds. While the overall returns might not be the highest available, the journey has not been as bumpy.

How have our fixed income Wealth Shortlist funds performed?

Our Wealth Shortlist bond funds have delivered mixed performance over the past year. Some have outperformed their peer group, while others have underperformed.

We wouldn’t expect them all to perform the same though. If all your funds in a sector are performing well at the same time, they're probably investing in similar areas.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a long-term diversified portfolio.

For more details on each fund’s objectives, risks and charges, see the links to their factsheets and key investor information below.