The UK government is facing increasing pressure to finance its operations, with an estimated £115 billion in borrowing expected this financial year alone, a significant rise from a decade ago. This increased borrowing is being financed through the gilts market, where government bonds, known as gilts, are sold to investors. These bonds, which have varying maturities from a few months to over 50 years, are considered a safe investment as the UK government has a long history of repayment.
However, a combination of global unrest necessitating increased defense spending and rising inflation has made investors more anxious, leading them to demand higher returns. Consequently, interest rates on gilts have surged. For instance, 30-year gilts, which paid less than 1 percent five years ago, now offer over 5.9 percent interest, the highest since 1998. Ten-year gilts are yielding around 5.3 percent, a rate higher than during the global financial crisis.
This situation presents both challenges for the government and opportunities for investors. Brokers and online platforms are offering a variety of gilts with high interest rates. While the coupon, or interest rate, of a gilt remains fixed after issuance, its price fluctuates daily based on investor demand, affecting the yield. For example, a gilt issued in 2025 maturing in 2056 with a 5.375 percent coupon is currently trading at £92.60, offering a yield of over 5.8 percent. Additionally, gilts are exempt from capital gains tax, further enhancing their appeal to savers. When considering the tax-free capital gain from the difference between the purchase price and the £100 redemption value, the gross yield on this particular gilt exceeds 5.9 percent.
Investors can choose to hold gilts until maturity or sell them on the secondary market. The price of gilts can fall if market sentiment turns negative regarding the UK economy, but it could also rise if economic outlook improves. The tax treatment of gilts is a significant attraction for many investors. During the COVID-19 pandemic, substantial quantities of gilts were issued with very low coupons, and these are now trading at significant discounts. For example, a gilt issued in June 2020 maturing in January 2028 with a 0.125 percent coupon is priced at £94.40, offering a tax-free gain of £5.60 upon maturity. For a higher-rate taxpayer, this equates to a gross equivalent yield of 6.8 percent, significantly outperforming cash accounts.
Longer-dated gilts also present opportunities. A gilt issued in May 2020 maturing in 2061 with a 0.5 percent coupon is priced at £21.90, offering an interest rate near 3 percent and a substantial tax-free capital gain of £88.10 upon maturity. These are particularly attractive for investors with long-term plans or those considering intergenerational wealth transfer. The flexibility to trade gilts, similar to shares, offers potential for gains, especially in an improving interest rate environment.
Experts advise caution, noting that while current yields are high, they could increase further, leading to a fall in gilt prices. For investors planning to hold gilts until maturity, key metrics include the current coupon, purchase price, and redemption value. For very long-dated bonds, inflation is also a critical factor, as it can erode the real value of the £100 redemption amount. Index-linked bonds, which adjust interest and capital repayments to inflation, are also available, with maturities extending to 2073.
Beyond gilts, the UK government also issues Treasury bills, which mature in one, three, or six months. These are sold at a discount and pay £100 upon maturity. For instance, a six-month bill issued at just over £98 offers a yield of more than 4 percent. These are subject to taxation unless held in an ISA or Sipp.
While government debt is considered very safe, other entities like companies, charities, and non-profit organizations also issue bonds. Corporate bonds, however, carry higher risk as companies can default, though they typically offer higher coupons to compensate. For example, a Tesco bond issued in 1999 with a 6 percent coupon, maturing in three years, is currently priced at £103, yielding 5.23 percent to maturity. Mortgage specialist LendInvest offers a bond maturing in 2032 with an 8 percent coupon, yielding 7.8 percent, reflecting its higher risk profile.
Charitable organizations also issue bonds. Belong, a care home operator, has bonds maturing in 2033 with a 7.5 percent coupon, which have risen to over £106 due to investor demand. The Charities Aid Foundation, despite a recent data breach, has a bond issued in 2021 with a 3.5 percent coupon trading at £87, yielding nearly 6.5 percent to maturity, with negligible default risk.
Bonds can add stability to investment portfolios and provide a consistent income stream. Investors have various options for purchasing gilts and bonds through platforms like AJ Bell, Hargreaves Lansdown, and Interactive Investor. They can also invest in bond funds, such as index-tracking gilt funds or actively managed corporate bond funds, which offer broader market exposure but may lack the tax advantages of direct gilt holdings.