UK Gilts

UK Government bonds are known as Gilts, due to the fact that the original bond certificates had gilded edges, known and accepted as an indicator of high quality, in turn implying little risk of loss or devaluation.

Types Of Gilt

There are two types of Gilts, Conventional and Index-Linked issues, but both are, to a greater or lesser extent sensitive to changes in interest rates.

The main difference lies in the degree of inflation protection offered by the latter, whose Principal value rises by the inflation rate prior to the coupon being calculated- this means that investors do not lose out as a result in a rise in economy-wide prices.

This is not true of Conventional Gilts, whose real terms value falls (as both the principal amount of the bond AND the coupons being paid are before inflation is taken into account).

Although they can both respond to political factors, this normally reflects the extent to which these factors have implications for the future path of interest rates.

Bond yields move inversely to their price, such that a rise in yields will imply a price decline and vice versa.

Investors buy them because they offer a low-risk diversification to other assets- they tend to move in opposite directions to shares for example and pay regular (normally semi-annual) payments, providing a predictable income stream, which is useful for many institutions, such a pension funds or insurance companies.

Bank of England BoE in London
UK Gilts are sold via the Bank of England

How To Trade Gilts

There are 3 main ways to access Gilts;

  1. Investing directly in Gilts; this used to be possible via the Post Office or direct from the BoE but is sadly no longer so.
  2. Buying ETFs which themselves invest in Gilts or
  3. Trading Bond futures (on the long or short side).

Direct From BoE

Gilt issuance is almost exclusively the preserve of Institutions (not retail investors), who buy them directly from the Bank Of England at one of their regular (Quarterly) auctions.

Individual investors must generally buy them on the secondary market, in the same way they do with shares, usually through a broker [1]. One will pay commission to a broker, (execution-only brokerage fees tend to be lower) on the purchase, but there are no management fees involved.

Gilt ETFs (or OEICS)

Buying Gilt ETFs (or indeed mutual funds, known as OEICS in the UK) is a common way of investing in UK bonds, as they do not require a large initial investment amount- (£500 would be enough for many fund managers).

Unlike buying Gilts themselves, which have an expiration (or maturity) date, Gilt funds continue in perpetuity, so one does not need to wait for a specific maturity date to get one’s money back.

These can be bought directly from the fund management house or again via a broker, though the former is considerably cheaper (though not free, as the firm will charge a management fee for running the fund itself).

Bond Futures

Bond futures are derivatives of the underlying bond markets and tend to be more suitable for short-term trading as they are considerably more volatile than the underlying bonds upon which they are based and allow speculative investments to be made using only a small fraction of the total value of the underlying contract- this gearing (or leverage) will magnify both profits and losses on individual trades.

Again a futures broker will be needed to gain access to this market segment, with the investor putting up margin (collateral) against these trades.

Buying Gilts through a broker (or investment platform) will require one to open an account with that firm and deposit money to the value of the desired investment amount.

If one is dealing via an execution-only service, it is desirable to have access to “live” (or only slightly delayed) prices, as this reduces the possibility of paying too high a price as a result of market moves that have not yet filtered through into daily close prices.

This is not easy to find, but a broker will normally be able to tell you the current price.

Many websites are good sources of data (for Yield to Maturity, Duration etc) and have charting facilities, though as they are often price delayed, this needs to be taken into consideration before buying.

Buying Gilts involves essentially the same process as for shares. Many of the brokers who facilitate share buying can also provide Gilt trading services; it is important to understand however, that the motivation for buying shares and bonds are fundamentally different and so it essential that due diligence is performed prior to the purchase of Government bonds, regardless of their yield, maturity and currency.

[1] There is an exception to this general tendency however, as occasionally, the Debt Management Office will sell some Gilts directly to the public at either a Fixed Price or by Tender, whereby an individual can “bid” for the bonds.

This avoids paying dealing commission, but one needs to be an “approved” Investor, with involves applying for and being accepted as such. This can be done via the Computershare Investor Services website, which involves them checking both the identity and the source of funds of an investor (for anti-money laundering purposes).