Investing in Gilts: Types, Benefits, and How to Get Started

Government bonds issued by the UK, known as gilts, offer stable returns with relatively low risk. They serve both personal and institutional investors by providing predictable income and capital preservation.

Investors value gilts for their security, steady interest payments, and potential tax benefits. While generally safe, understanding their mechanics is essential before investing.

Types of Gilts

Different types of gilts cater to various investment needs, whether for steady income, inflation protection, or trading flexibility.

Conventional Gilts

These are the most common type and function like standard fixed-income securities. They have a set maturity date, at which point the principal is repaid, and they pay a fixed interest rate, known as the coupon, at regular intervals. The UK Debt Management Office (DMO) issues them with short-term (under seven years), medium-term (seven to 15 years), and long-term (over 15 years) maturities.

Their market prices fluctuate based on interest rate movements and economic conditions. Rising interest rates reduce the value of existing gilts with lower coupons, while declining rates increase the value of older gilts with higher coupons. Investors holding them until maturity receive full principal repayment, while those selling earlier may gain or lose depending on market conditions.

Index-Linked Gilts

These gilts adjust both principal and interest payments in line with the UK Retail Prices Index (RPI). As inflation rises, payments increase, making them attractive to investors seeking to preserve purchasing power, such as pension funds and long-term savers.

Since payments are tied to inflation, they hedge against rising costs. However, in low-inflation environments, their appeal diminishes. Market value is influenced by inflation expectations, making them sensitive to economic shifts.

Strippable Gilts

Some gilts allow for “stripping,” where interest payments and principal repayment are separated and sold as individual securities. This creates two investment products: interest-only strips providing periodic income and principal-only strips paying a lump sum at maturity.

Strippable gilts cater to investors with specific cash flow needs, such as institutions matching future liabilities or individuals planning for large expenses. Since these stripped components trade independently, their pricing is influenced by different factors than traditional gilts.

The Role of Coupon Payments

Gilts provide regular income through coupon payments, which are fixed or inflation-adjusted interest payments made by the UK government. These payments are distributed semi-annually. The coupon rate remains fixed for conventional gilts, while index-linked gilts adjust based on inflation.

Market conditions, particularly interest rates, influence the yield investors receive. When rates rise, newly issued gilts offer higher coupons, making older bonds with lower payments less attractive and reducing their market price. Conversely, falling rates make older gilts with higher coupons more desirable, pushing prices up.

Tax considerations also impact coupon payments. In the UK, gilt interest is subject to income tax but is exempt from capital gains tax. This makes them appealing to investors in lower tax brackets or those holding gilts within tax-efficient accounts such as Individual Savings Accounts (ISAs) or Self-Invested Personal Pensions (SIPPs). Institutional investors also factor in tax treatment when allocating gilts.

Buying Gilts

Investors can buy gilts through several channels. One method is the UK Debt Management Office’s (DMO) Gilt Auctions, where new issues are sold to the highest bidders. These auctions, held regularly, are primarily for institutional investors, though individuals can participate through approved intermediaries.

Retail investors can purchase gilts via brokerage firms and investment platforms, which offer access to both new issues and existing gilts. These platforms provide research tools, historical pricing data, and yield comparisons to help buyers make informed decisions. Some brokers offer nominee accounts, simplifying administrative tasks such as collecting interest payments.

Another option is investing in gilt-focused exchange-traded funds (ETFs) or mutual funds. These funds pool capital from multiple investors and allocate it across various maturities, providing diversification and professional management. This approach suits those wanting exposure to gilts without managing individual securities.

Redemption and Maturity

When a gilt reaches maturity, the UK government repays the principal to the bondholder. Maturity periods vary, with short-dated gilts maturing within seven years, medium-dated between seven and 15 years, and long-dated extending beyond 15 years. Longer durations are more sensitive to interest rate changes.

Some gilts include special features affecting final payouts. Floating rate gilts adjust their interest payments periodically based on prevailing rates. Callable gilts, though rare in the UK, allow the government to redeem them early. Investors should assess these terms as they impact cash flow planning and reinvestment strategies.

Tax Treatment

The tax implications of investing in gilts depend on the type of return an investor receives. Interest payments are subject to UK income tax at an individual’s marginal rate—20% for basic rate taxpayers, 40% for higher rate taxpayers, and 45% for additional rate taxpayers. However, gilts are exempt from capital gains tax, meaning any profit from selling them at a higher price than the purchase cost is not taxable.

Holding gilts within tax-advantaged accounts such as ISAs or SIPPs allows investors to receive interest payments tax-free. Institutional investors, such as pension funds and insurance companies, may also benefit from specific tax treatments depending on their regulatory structure. Some gilts qualify as Qualifying Corporate Bonds (QCBs), offering additional tax advantages for certain investors.

Trading in the Secondary Market

While some investors hold gilts until maturity, others trade them in the secondary market to capitalize on price fluctuations. The London Stock Exchange facilitates gilt trading, allowing investors to buy and sell based on prevailing interest rates, inflation expectations, and economic conditions.

Liquidity in the secondary market varies. Benchmark issues, typically those with larger issuance sizes and longer maturities, tend to have higher trading volumes, making them easier to buy and sell. Less liquid gilts may have wider bid-ask spreads, increasing transaction costs. Institutional investors, such as pension funds and asset managers, are major participants in this market, influencing pricing trends. Retail investors can access the secondary market through brokers but should be mindful of transaction fees and market timing risks.