Everything you need to know about investing in gilts

Bonds issued by the UK government, known as gilts, are back on the radar of investors due to their higher yields, which offer investors a greater level of income.

But to start with, let’s take a step back and explain what a gilt is, and how bond prices and bond yields work in practice.

• Invest with ii: Investing in Bonds | What is a Managed ISA? | Open a SIPP

What is a gilt?

Investors buying gilts are lending money to the government, known as the principal, which operates like an IOU. While waiting for the money to be repaid at a specified date in the future when the gilt matures, investors are paid interest at a fixed rate known as the coupon. This payment typically happens twice a year. Gilts are traded in £100 denominations. 

Gilts are lower-risk compared to other bond types – such as corporate bonds – due to the security of the issuer, which is the UK government.

Over the past decade, the income offered by gilts – the yield – has been very low. However, this has dramatically changed over the past two years on the back of interest rates rising from just 0.1% to 5.25%, and currently sitting at 5%. Interest rate rises have caused the prices of gilts to crash, sending yields higher. Investors sell bonds when interest rates rise, as they know they can get a better deal on newly issued debt. However, lower interest rates are now causing bonds to rally. 

• What are bonds?
• What are gilts?
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

The yield is the annual return that an investor who’s bought the gilt should receive if they hold the bond to maturity. It is known as the yield to maturity or gross redemption yield, which is different to the running or distribution yield, which just accounts for the coupons paid out and not the return of the principal when the gilt matures. 

Bond prices and bond yields have an inverse relationship, so falling gilt prices mean higher gilt yields. When gilt prices rise, yields fall. 

Usually, bonds with longer lifespans such as 30 years have higher yields than shorter-duration bonds to compensate investors for lending their money for longer. 

The table below shows the yields on offer from key UK gilt maturities.

Source: MarketWatch, 22 August 2024. Past performance is not a guide to future performance.

Investors can buy gilts directly or invest in actively or passively managed funds that hold them. But understanding how to buy them, and how they are affected by markets, is not always straightforward.

Gilt yields explained

The yield on a bond is the relationship between the price of the bond and the coupon it pays. As explained above, bond yields move inversely to bond prices. When bond prices rise, yields fall, and vice versa.

The running yield, which shows how much will be distributed annually as income, is calculated by dividing the coupon by the price, and multiplying by 100.

For example, a bond issued at £100 with a 5p coupon, has a yield of 5%. However, if the price rises to £200, the coupon is still 5p, but the yield falls to 2.5%. In this scenario, those who bought when the bond was issued, can now sell at double the price they paid.

• How to invest in bonds and gilts
• Tax rules for bonds and gilts

If the price falls to £50, the coupon remains at 5p, but the yield is now 10%. While the amount expected to be paid in income is now relatively higher, those who bought at issue and decide to sell will be doing so at a loss of 50% on the price paid. For new investors, the higher yield and cheaper price on offer are more attractive.

The yield to maturity, which incorporates the gain or loss when the £100 principal of a gilt is returned, is another yield to be aware of, as it can vary greatly from the running yield.

For example, TN25, a gilt maturing in January 2025, has a coupon of 0.25% and price of £98.3. This means the running yield is 0.254% (0.25 divided by 98.3, multiplied by 100). However, including the £100 returned to investors when the bond matures, the total annualised gain of holding this bond to maturity is currently 4.14%, according to data provider Tradeweb. Yield to maturity is most useful for investors looking to hold bonds to maturity.

Why did gilts fall in price?

The main driver of gilt prices rising or falling is interest rates. When interest rates rise, any new gilts issued come with higher coupons. This makes existing gilts less attractive, causing their price to fall.

Interest rates rise to cool the economy and bring down inflation. Higher borrowing costs have an enormous impact on mortgage costs for millions of households.

The reverse scenario plays out when interest rates are cut. Newer gilt issues pay less in interest, which in turn makes existing gilts look more attractive.

Understanding direct gilts

Finding the right gilt to invest in and understanding what you are buying is not always straightforward.

Gilts follow the same naming pattern, and all look something like this: Treasury Gilt 0.25% 31/01/2025 (TN25)

Treasury gilt, sometimes shown as just Treasury or United Kingdom, shows that it is a bond issued by the UK government.

• Is inflation beaten? The impact on stocks and bonds explained
• DIY Investor Diary: why I’m ‘all in’ on this volatile gilt

The next number will be the initial coupon paid, expressed as a percentage. This shows the yield that the investors who participated in the bond issue were able to obtain. The bond may have been issued slightly above or below the par value of £100, depending on investor demand, which therefore might change the initial yield that investors got.

The date is the maturity date of the bond. This is when the final coupon payment is made and the £100 par value of the bond returned to those who own the bond. Coupons are paid twice a year.

TN25 is the stock market ticker for the bond. You may also see T, TR or TG. The number refers to the year the gilt will mature.

How to invest

Interactive investor offers around 100 gilts on the platform. The most popular ones can be traded online, while some may have to be traded over the phone. Online dealing costs are charged, rather than the higher phone dealing charge. Here you can find a table of the gilts we offer. 

We have also started to offer access to some gilts when the Debt Management Office (DMO) auctions them. They will appear on the IPO page here.

So, what are the advantages of participating in gilt auctions rather than buying gilts already in issue?

First, it is cheaper. There is no commission to ii to participate in the auction, and no bid/offer spread to pay or trading fee (£3.99 if dealing online at ii), unlike when trading gilts already in issue.

Another key advantage is that investors have more clarity on the yield they will receive, which is set following the auction. When buying gilts trading in the secondary market, the yield is a result of the market price of the gilt, which is trickier to calculate. 

Investors can choose to hold the gilt bought at auction to maturity, and therefore do not have to worry about price fluctuations, or selling the bond on the secondary market.

• Benstead on Bonds: why gilt auction access is a win for small investors
• Benstead on Bonds: the four gilts investors are backing – should you too?

Auctioned vs syndicated gilts 

Most gilts come to market via an auction process, where investors put in bids at different prices and run the risk of not receiving any bonds if they put a bid in that is too low.  Or they can put in a non-competitive bid at the average price, as ii does on behalf of customers. 

However, sometimes the DMO uses a “syndication” process, whereby banks market the gilt to their clients – like on a corporate bond deal – which creates a “pot” into which orders go and then the correct market clearing price is found for gilts distributed to a bank's clients.

From an ii customer perspective, while there is a difference between an auction and syndicated deal, the investment process will be similar.  

Tax breaks explained

Income from gilts, coming from the coupon paid twice a year, is subject to income tax if not held inside an ISA or a SIPP.

However, capital gains from selling a gilt, or when it redeems, are not subject to capital gains tax. This makes them a useful tax-planning tool for investors who have used up their ISA and SIPP allowances.

For some gilts, most of the total return is when the gilt redeems at £100, meaning that the capital gains tax savings are significant.

• Don’t be shy, ask ii….why is this inflation-linked bond fund losing money?
• Benstead on Bonds: stock market wobble shows why we own bonds

What about index-linked gilts?

The UK government also issues index-linked bonds, where the coupons and principal are linked to the RPI inflation rate. Aimed at large investors who need to secure an income above inflation, they are generally very long duration bonds, meaning that they take a long time to mature and pay back the bond owner in full.

Inflation-linked bonds will generally rise in price when interest rates fall, just as normal bonds do, but will also perform well when inflation rises, which is a scenario that may hurt normal bonds as the real value of their coupon will be eroded.

Rising interest rates hurt inflation-linked bonds as they do normal bonds, so a scenario of high and rising inflation without higher interest rates is ideal for this type of bond. Inflation-linked bonds, due to their longer maturity lengths, tend to be more sensitive to interest rate changes than regular bonds.

Investors can buy inflation-linked bonds directly, or they can buy a fund of them, such as the iShares £ Index-Linked Gilts UCITS ETF. Index-linked gilts are more complicated than regular gilts due to how they calculate coupon payments and the final principal amount, so require more research.

For example, the iShares ETF has not made an income distribution since 2020. This is because of an accounting practice called amortisation that means income is being added to the capital value of these funds and not paid out, even in the income share classes. 

Index-linked gilts follow the same naming pattern as regular gilts, but normally include “IL” in the name. 

Which gilts are ii customers buying?

As of August 2024, interactive investor customers are buying up gilts set to mature in the next couple of years. This suggests investors are holding the gilts to maturity, locking in yields of around 4%

The most popular by quite a margin is TN25, full name: UNITED KINGDOM 0.25 31/01/2025. A large part of the bond’s return comes from capital gains when the bond matures, as the annual coupon is tiny at just 25p per £100 bond. It’s so low because interest rates were just 0.1% in the UK when the bond was issued in June 2021. 

The next most-popular bond is T26 – investors own this for the same reasons they own TN25. Like TN25, it has a very low coupon, at just 12.5p per £100 bond, because it was issued in May 2020, when interest rates were near zero and investors were worried about the economy after Covid struck.  

The next most-popular gilt offers something a little different. The TR25 gilt has a £5 annual coupon, indicating that it yielded around 5% when it was issued in December 2024. Given that that’s not far off what gilts yield today, the price is very close to par, at £102.5, meaning that the yield to maturity is slightly below the coupon, at 4.6%. 

• Bond Watch: ii unlocks access to UK Treasury Bills
• Day in the life of a bond fund manager: M&G’s Eva Sun-Wai

One popular gilt that stands out is TG61, a bond with just under 40 years until it matures. Long-dated bonds are most sensitive to changes in interest rates, and so will generally fall in value the most when rates rise, but rise the most when they fall.

The popularity of this bond suggests that some investors are betting that interest rates will fall faster than the markets expect, and they hope to sell the gilt for a capital gain before it matures. This is also tax free.

Popular gilts on ii

Source: Tradeweb, 22 August 2024. Past performance is not a guide to future performance.