Investing in Gilts: A Comprehensive Guide

Borrowing is a familiar concept in our financial journeys. A loan from financial institutions can help you grab the latest machine on wheels or fast-track your business growth. But do you know you can also lend money to the government in exchange for a regular income? That’s right. The UK government may issue bonds to finance its spending program. Such an amount is called gilt. 

In recent years, these investment vehicles have moved into the financial centre stage as more people rush to grab low-risk, stable income streams. But what exactly are gilts, and how do you invest in them? In this article, our experts answer these burning questions to help you start investing on the right foot. 

What Are Gilts?

Let’s start with the most important question: what are gilts? 

Gilts are government-issued bonds in the UK, India, and Commonwealth territories. The USA has a similar version called US Treasury securities. When the government issues you gilts, it’s basically borrowing money from you at a regular interest rate. You’ll then get the principal amount back at a specific bond maturity date. 

Gilts come in two primary types:

• Conventional gilts: They pay you a fixed coupon, typically semi-annually. They also have a set maturity date when you get the principal repayment. UK’s gilts usually mature after five, 10, 30, 50, or 55 years. 
• Index-linked gilts: These bonds’ principal repayment and coupons are adjusted semi-annually according to inflation–when it rises, the amounts rise and vice versa. Thus, you can use them as a hedge against inflations. 
• Strips: These are gilt securities that depend on the principal amount or coupon.

So, how do gilts work to generate an income? Our experts broke down the key elements you need to know:

• Issuer: This is the borrower, in this case, the government.
• Coupon: It’s the annual interest rate at which your principal amount earns you an income.
• Yield: It’s the actual return based on your initial purchase price and interest rate. 
• Maturity: Date you’ll receive back your principal amount.

For example, suppose the government plans to borrow £500 at a 5% annual interest rate. Typically, it will issue the bonds at “par” (face value) or £100. If you buy a unit (100p) of the gilt, you’ll get 5p annually. You’ll typically receive your initial investment at a face value of £100 during the redemption or maturity date. 

Why Invest in Gilts?

The British government has solid creditworthiness—it has always cleared interest to gilt holders. A bit of history: this borrowing arrangement began in 1694 when the government needed to fund a war with France.  

So, while gilts investments have low rates of return and depend on interest rate changes, they aren’t as risky as many other asset classes. Here are the benefits of investing in gilts:

• Security: You get the peace of mind knowing you’re investing in a government-backed investment vehicle. 
• Regular income: You can get a predictable and regular coupon throughout the bond’s lifetime. 
• Diversification: Does your portfolio include more volatile assets like commodities or stocks? You may include gilts in it to hedge against investment risks.
• Inflation protection: With index-linked gilts, your principal and income will maintain their real value throughout rising and falling inflation. 
• Liquidity: You can easily buy and sell these vehicles in a secondary market without significant loss. 

Therefore, we recommend gilts if you’ve been dreaming of owning a more stable and secure investment vehicle. They can boost your diversification strategy because they aren’t highly correlated with stock markets. 

How to Invest in Gilts?

Investing in gilts is a breeze. There are several options depending on your financial goals and preferences.

You can purchase directly from the UK Debt Management Office (DMO) through auctions. However, because of the large capital requirement, this path is more suitable for institutional investors or heavy-money individuals. 

Another option is to buy via a broker. Online trading platforms have gathered a tribe of gilt investors because of their low capital requirements. But remember to check a broker’s fees, as they can quickly eat into your income. 

Alternatively, you can invest via gilt-focused funds. These vehicles pool money from multiple investors to purchase a diversified gilt portfolio. We recommend this option if you desire professional management and diversification within the asset class. 

Another path is purchasing in secondary markets. This transaction involves buying gilts from another investor after their initial issuance. Thanks to changing prices (due to fluctuating interest rates, inflation expectations, and demand), you can potentially get one at a lower price. 

How Gilts Generate Income

Gilts generally offer regular income–typically, you get a fixed coupon semi-annually. For example, suppose you invest £10,000 in a 3% Treasury Stock 2030. You’ll get semi-annual payments of £150, totalling £300 annually. 

You may prefer conventional gilts because of their fixed income stream. However, index-linked ones are more suitable if you desire extra protection against inflation. Either way, gilts are preferable if you’ve retired or want a less volatile investment. 

Risks of Investing in Gilts

While gilts are low-risk assets, risks always haunt any form of investment. We encountered the following notorious pitfalls in our research:

1. Interest rate changes

A rise in the interest rate pushes existing gilts’ prices down. Why? Usually, the government issues new gilts at higher coupon rates, making the older ones less preferable. That means your selling price may be lower than the initial investment.

2. Inflation risk

If you’re a conventional gilt-holder, your coupon will remain fixed, even if the inflation rises. That translates to a lower absolute value of your yield. That’s why index-linked gilts are darlings amongst some investors. 

Strategies for Investing in Gilts

A successful trade requires a rock-solid strategy that suits your financial goals and risk tolerance. Our experts assembled strategies that investors use to make a kill:

How to Choose Gilts

The right gilt will help you accomplish your financial dream. But how do you identify it from a clutter of options? You should consider your investment goals, maturity period, coupon rate, risk factors, market conditions, diversification strategy, and secondary market opportunities.

Conclusion

Gilts are a secure and predictable money-making investment vehicle. You can bid farewell to high-risk income streams and buy conventional or index-linked gilts to achieve your dreams. But like any investment, these vehicles come with their share of risks. 

We recommend sticking to the good old strategy of diversification. Also, monitor economic conditions and ensure your chosen gilts are tailored to your financial goals. Other tactics include laddering and buy-and-hold strategies.