A common motivation for investors is the desire to beat inflation and preserve their wealth. As we’re all aware, cash savings slowly lose their buying power over the years, so investors often seek out the inflation-beating potential of other assets, such as equities.

With inflation currently at much higher levels than we’ve become used to, it is harder for equity returns to outpace it, at least in the short term. Meanwhile, gilts, which tend to perform well under these economic conditions, become more interesting.

Gilts are usually seen as a low-risk, low-return investment

Gilts are bonds issued by the UK government and are listed on the London Stock Exchange. They are the British equivalent of what is known in the US as ‘US Treasuries’. They are considered to have a low risk of default and, correspondingly, a low rate of return.

Gilts pay a regular income stream known as a ‘coupon’ which is normally paid on an annual or semi-annual basis.

Since the global financial crisis, interest rates have been near rock bottom, which has made UK government bonds an unattractive option for investors. Rather than providing meaningful levels of return, gilts have primarily been used as a diversifier within multi-asset portfolios, due to their historically low correlation with equities.

Gilt returns can be calculated in two ways

The return on gilts can be expressed in two ways: the running yield or the gross redemption yield.

The running yield reflects the annual coupon (i.e. the interest payment) as a percentage of the purchase price. For example, if the annual coupon payment is £5 and the price is £90, the running yield would simply be 5.6%.

The gross redemption yield (GRY) also includes the difference between the gilt’s purchase price and its face value at maturity. The calculation is a little more complex, but assuming the face value of the gilt is £100 and it has 5 years until maturity, we can calculate the GRY as being 7.78%.

Recently, the inflationary environment has boosted returns

Bond yields and bond prices are inversely related, so when the bond yield rises, the bond price falls and vice versa.

Bond yields are also positively correlated to changes in interest rates. As inflation and interest rates have been rising since the beginning of 2022, this has led to bond yields also rising, while bond prices fall. As such, the GRY (which includes both the coupon rate paid by a bond and the difference between its current price and value at maturity) has presented a good opportunity for bond investors.

Additionally, gilts qualify for various tax benefits

Gilts are exempt from capital gains tax (CGT), which means that you don’t have to pay CGT on any profits you make when a bond is sold or redeemed. This presents a good opportunity for higher-rate or additional-rate taxpayers, who would normally be subject to CGT of 20% on any gains crystallised above the CGT allowance (£6,000 for 2023/24).

Additionally, any gilts held within a stocks and shares ISA (individual savings account) or a self-invested personal pension (SIPP) are not subject to income tax.

In a taxable savings account, any interest earned over your personal savings allowance (£1,000 for basic-rate taxpayers, £500pa for higher-rate taxpayers, and £0 for additional-rate taxpayers) is taxed at your marginal tax rate. With gilts, income tax only applies on coupon payments, which are currently quite low, especially for short-dated gilts. Therefore, most of the gilt’s overall return is driven by the capital return (which is tax-free), rather than the income payment.

Given where we are in the current interest rate cycle, short-dated UK government and corporate bonds can offer relatively high returns (even compared with other asset classes such as equities) without taking on too much interest rate, credit or volatility risk.

If you are interested in investing in gilts or you would like to find out more about their role in your investment portfolio, please do not hesitate to get in touch.

About the author

To contact or read more about Gabriela Gyurova, visit her biography here.


Important information

Tax treatment depends on individual circumstances. All statements concerning tax treatment are based upon our understanding of current tax law and HMRC practise and can be subject to change.

The information contained in this article does not constitute a personal recommendation and the investment or investment services referred to may not be suitable for all investors. Any opinion or estimate expressed in this publication is Investec Wealth & Investment’s current opinion as of the date of this article and is subject to change without notice. The value of investments and any income from them is not guaranteed and may go down as well as up; you may get back less than the amount invested. Past performance is not an indication of future performance.

Investec Wealth & Investment (UK) is a trading name of Investec Wealth & Investment Limited which is a subsidiary of Rathbones Group Plc. Investec Wealth & Investment Limited is authorised and regulated by the Financial Conduct Authority and is registered in England. Registered No. 2122340. Registered Office: 30 Gresham Street. London. EC2V 7QN.