Important notes
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
24 April 2024
Maturity of directly owned gilts
Sky high interest rate hikes have meant lots of investors have been buying gilts directly recently as part of their portfolios. Gilts are bonds issued by the UK government. For many, this will likely be the first time they have ever invested in bonds of any kind outside of an investment fund.
One of the biggest differences between investing in bonds through a fund and buying them directly, is that a fund doesn’t have a maturity date, but individual bonds do.
Remember that when you invest in a bond, you are lending money to the bond issuer. In return for lending them money, they will pay you coupons (interest payments) and then when the bond matures, return your capital too. The return of capital at the end is called the maturity (or par) value.
If investors hold bonds through a fund, they don’t need to worry about maturity values. The fund manager will manage the cashflows and reinvest them into other bonds.
However for investors who own bonds directly, they are unlikely to be used to receiving lump sums of this size into their investment portfolios when bonds mature. It’s important that investors are aware that these lump sums are coming and have a plan of what to do with them once received. Otherwise they are at risk of leaving potentially large amounts of assets uninvested and in cash.
While that may be a suitable outcome for some investors, it is likely that most would want to reinvest the proceeds quickly once received.
Here we provide our latest outlook for gilts and bonds, along with some of the options for investors to consider what to do with the maturity values they will receive.
This is not personal advice or a recommendation of where to invest. If you’re not sure what’s right for you ask for advice. Investments, and any income from them, will fall as well as rise in value.
Breakdown of the gilt yield
The overall yield is the annualised return you get when you buy the bond between purchase date and maturity.
The coupon is like interest you receive from a savings account. It is usually fixed for the length of the bond.
The capital gain changes as the price and yield change over time.
| Overall Yield | Coupon |
| Capital Gain |
For example, if the gilt yield is 4% and the coupon is 1%, the capital gain element is going to be 3%.
But, now assume there are changes in the price of gilts and the yield reduces to 3%. The coupon for this same bond will still be 1%, which means that the capital gain will reduce to 2%.
Outlook for gilts
Interest rates are likely at their peak for this cycle, with the broad expectation being for rates to come down from here. This is good for bonds as falling yields means increasing prices.
Current market pricing is suggesting that interest rates in the UK will be around 3.25-3.5% in five years’ time. This figure is around 3.6% for US interest rates and 2-2.25% for Europe. If this turns out to be correct, then that will mean interest rate cuts from three of the most influential central banks globally in the coming months and years.
While yields available on gilts today are lower than they were in the 3rd quarter of 2023 (meaning that gilts are more expensive to buy than they were), they are still offering good value compared to the last 15 years or so. Prior to the Truss-Kwarteng mini budget crisis in September 2022, the last time the 10-year gilt yield was above 4% was before the financial crisis in 2008.
With inflation coming down steadily towards target, this will also be less of a headwind to bonds generally, further increasing their appeal to investors.
Following the increase in bond yields generally, they are more likely to provide diversification benefits to investment portfolios going forward compared to recent years. Although of course, there are no guarantees.
When bond yields were very low, there was limited scope for them to reduce further (and therefore increase in value). This meant that in a market shock (when shares tend to fall), the best case scenario for bonds was probably that they would hold their value.
This would still have been a better outcome than the potential sell off in shares. However, now that yields are higher again, in the event of a market shock, it is possible that bonds will increase in value. This is particularly true for government bonds such as gilts, that could benefit from a safe haven trade in a market shock environment. The potential for bonds to increase in value in this scenario increases their diversification benefit within an investment portfolio.
Past performance isn't a guide to the future. Source: LSEG Datastream, March 2024
Investors accumulating wealth prior to retirement
Gilts can act as a diversifier within investment portfolios and provide an income.
The nice thing about investing in gilts directly rather than through a fund is that if you hold the gilt to maturity, the overall return is known and guaranteed between the date you invest and the maturity date – assuming the UK government doesn’t default on their gilt payments that is.
This is appealing to lots of investors.
However, the 10-year gilt yield is currently around 4%. Which means if you bought a gilt today that matures in 10 years’ time, the annualised return you will receive on that bond is going to be around 4%. This return is a combination of coupon payments (interest) and capital gains.
While this is appealing, for investors looking to generate long-term growth, there are other potential options that may be more appropriate, particularly over longer time horizons.
For investors with very long-term time horizons, our view would be that shares (either held directly or via funds) are likely to be a better option for increasing their wealth, so long as the inevitable ups and downs don’t present a problem and investors are comfortable with the risk they may get back less than they invest.
For those investors who are approaching retirement or who may need access to their assets in the shorter term, holding some gilts (or bonds) definitely has its benefits.
The expected smoother return profile of the overall portfolio (due to higher levels of diversification) means that it’s less likely that if investors suddenly needed to take some of their money back, that the portfolio would have suffered a significant loss. Although as always, there are no guarantees.
For investors who receive gilt maturity payments who are in this scenario, consideration should be given to whether using the proceeds to invest in other types of asset would be more appropriate. It is quite possible though, that simply reinvesting the proceeds into another gilt may remain an appropriate investment decision too.
Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives align 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.
Fund ideas for growing your wealth before retirement
Legal & General Future World ESG Developed Index:
- Aims to provide long-term growth whilst taking into account environmental, social and governance considerations.
- Invests more than the broader global stock market in companies that score well on a variety of ESG criteria, such as the level of carbon emissions generated and number of women on the board. If companies score poorly on these measures the fund reduces exposure.
- Invested in around 1,400 global companies, focused towards sectors such as technology & communications, consumer non-cyclical and consumer cyclicals.
- We think this is a mid-ranged risk option within these selections and is a great option to help diversify a portfolio focused on shares or income. It may also mean a smoother journey compared to a portfolio focused entirely on shares and so may be a consideration for portfolios that don’t want to be open to all of the ups and downs of the stock market.
- The fund has the flexibility to use derivatives which adds risk if used.
LEGAL & GENERAL FUTURE WORLD ESG DEVELOPED INDEX FACTSHEET
LEGAL & GENERAL FUTURE WORLD ESG DEVELOPED INDEX KEY INVESTOR INFORMATION
BNY Mellon Multi-Asset Balanced:
- This fund likes to keep things simple, usually investing in a combination of shares, bonds and cash. Most of the fund is invested in shares though, with typically 70-80% of the fund invested there.
- We think the fund offers a great way to get exposure to shares from around the world, while also giving exposure to some government bonds.
- We think this is a mid-ranged risk option within these selections and is a great option to help diversify a portfolio focused on shares or income. It may also mean a smoother journey compared to a portfolio focused entirely on shares and so may be suitable for investors who don’t want to be open to all of the ups and downs of the stock market.
- The fund can invest in high yield bonds, emerging market companies, smaller companies and use derivatives, all of which add risk.
BNY MELLON MULTI-ASSET BALANCED FACTSHEET
BNY MELLON MULTI-ASSET BALANCED KEY INVESTOR INFORMATION
Troy Trojan:
- The fund invests in a mix of investments including shares, bonds, commodities and currencies and includes some of the world's best-known companies with highly recognisable brands.
- The fund has the flexibility to invest in higher-risk smaller companies and while the fund contains a diverse range of investments, it is concentrated, which is a higher-risk approach.
- It could help form part of the foundation of an investment portfolio, bring some stability to a more adventurous portfolio, or provide some long-term growth potential to a more conservative portfolio.
- We think this is the lowest risk option within these selections and could be a great option to reduce the volatility of a portfolio in the approach to retirement.
TROY TROJAN KEY INVESTOR INFORMATION
Investors looking to maximise their tax efficiency
Investors who purchase gilts directly, rather than through a fund, do not have to pay capital gains tax on any increases in their capital value between purchase and sale or maturity.
Note that there are securities available called Gilt Strips where no interest payments are made but all capital returns are taxed as income.
For some investors, particularly those who pay higher rate tax, this has made low coupon bonds very appealing. Coupons paid by gilts are taxed as income. Gilts with a low coupon are appealing because the majority of their returns come from a capital gain, which is not taxed.
It is important to understand that this doesn’t matter if you buy the gilt within a tax efficient wrapper such as an ISA or a SIPP. ISAs and SIPPs are products which mean that any income or capital gain from investments within them is not taxable.
When it comes to considering what to do with the proceeds from the maturity of a gilt, it is therefore important for investors to consider whether they have used all of their allowances within these wrappers rather than simply buying another low coupon gilt. For example, it could be that an investor would be better off making use of their ISA allowance rather than buying a gilt in an ordinary Fund and Share Account.
It is important to note that the majority of new gilts coming to market have much higher coupons compared to those issued in recent years. This means that the proportion of the total return that comes from a capital gain is likely to be lower for new gilts compared to some that are available at the moment.
For many investors who bought gilts to take advantage of the lack of capital gains tax, simply reinvesting the maturity value into another low coupon gilt could be a good option, however there might be better options available to them.
All investors will have different circumstances when it comes to tax and investors should seek financial advice if they are unsure of what to do with the proceeds of a gilt maturity.
Tax rules can change and benefits depend on individual circumstances.
Explaining gilt names on the HL website
Here is an example of a gilt name:
Treasury 0.125%
31/01/2028
GBP |
GB00BMBL1G81 | BMBL1G8
But what does all of this mean?
The name is usually broken down into 3 parts: the issuer (with gilts this is the UK Treasury), the coupon % and finally the maturity date.
Underneath are 3 further pieces of data - the currency (for gilts this should be GBP), the ISIN and the SEDOL. The ISIN and SEDOL are identifiers for trading systems and do not have any impact on the investment return.
Coupon (%) - this is the amount paid to the bond holder on an annual basis. It is shown as a percentage. When working out what amount this will mean in pounds and pence, you can simply take the percentage of £100. So in the example here, a coupon of 0.125% means a payment of £0.125 or 12.5p per year is paid to the bondholder as interest.
Maturity date - this is the date that the bond comes to an end and the bond issuer pays the bond holder the maturity (or par) value. The maturity (or par) value is usually £100 per bond.
Retirement income
Lots of people in retirement need income to supplement their pension. Gilts are just one of a number of different ways that income can be generated from investors’ assets.
One of the positives of investing directly in gilts for income is that, by and large, the coupon (interest) payments are fixed. This means that investors know what income they will receive during the life of the gilt. This is very attractive for people in retirement who want a specific level of income or who are managing their level of income for tax reasons.
Of course, there is the risk that the UK government defaults on their bond payments (doesn’t pay them), which might impact the coupon and maturity payments made. However this risk is a very small one, particularly when compared to the other options available.
Corporate bonds have similar characteristics to gilts, however they carry higher risk of default. This is particularly true for bonds issued by companies with lower credit ratings. These are often known as “high yield” bonds as the companies issuing them are considered more risky and therefore have to pay higher rates of interest to borrow. While they pay a higher level of income, investors need to be aware of the greater risk that these companies might default on some of their bond payments. To help manage default risk, investing in a blend of different bonds through an investment fund may be most appropriate.
The challenge with this for people in retirement is that the level of income paid by a fund is more variable. This is because the fund manager will buy and sell bonds at different points in time and will invest in bonds with lots of different yields. This means that the level of income you will receive from investing in a fund will change over time and is not guaranteed.
There is always the option of investing in shares that pay dividends as well. This can be done directly or via funds and our suggestion would be that funds are likely a better way to smooth out dividend income from a number of different companies, rather than relying on the dividend payments from just a few.
Remember that dividends are not guaranteed and could be stopped at any time, so investing for income via shares is naturally a bit more risky when it comes to knowing what the future income will be from your investment portfolio. Some markets (such as the UK) have a bias towards companies which pay dividends, which means that when considered across a lot of companies, the dividend income becomes more reliable.
Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives align 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.
Fund ideas for income in retirement
Artemis Corporate Bond:
- The fund aims to generate a combination of income and growth over the long term and could form part of a diversified bond portfolio or diversify an equity-focused portfolio.
- We think the fund could be a good choice as part of a portfolio that has a long-term view or a portfolio being built to provide income. But be aware it could be more volatile than other bond funds and the amount of income generated may vary.
- The fund can use derivatives and invest up to 20% in high-yield bonds, both of which add risk.
ARTEMIS CORPORATE BOND FACTSHEET
ARTEMIS CORPORATE BOND KEY INVESTOR INFORMATION
Fidelity Global Dividend:
- The manager, Daniel Roberts, is a highly experienced global investor with a focus on providing long-term income and growth whilst looking to provide shelter in weaker markets.
- We think this fund could provide diversification to an income-focused portfolio with the potential to provide some much needed shelter should markets become volatile.
- The manager can invest in derivatives and smaller companies which adds risk. The fund takes charges from capital, which can increase the yield but reduces the potential for capital growth. The level of income generated will vary.
FIDELITY GLOBAL DIVIDEND FACTSHEET
FIDELITY GLOBAL DIVIDEND KEY INVESTOR INFORMATION
Baillie Gifford Sustainable Income:
- The fund aims to increase how much it pays to investors by more than the increase in the consumer prices index (inflation), over the long term.
- We think this fund could be a useful addition to a portfolio focused on income or provide diversification to a portfolio focused on growth.
- The fund invests in emerging markets, high yield bonds and uses derivatives, all of which add risk. The fund takes charges from capital, which can increase the potential income paid, but reduce the potential for capital growth. The level of income generated will vary.
- Please note that this fund invests in Hargreaves Lansdown shares.
Important notes
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
