What Are Gilts and Should I Invest in Them?
A "gilt" or a "gilt-edged bond" is a bond issued by the Government of the United Kingdom. (Some other commonwealth countries, such as India and South Africa, also refer to their Government bonds as gilts.)
The term comes from the days when such bonds were issued on paper with a gilt edge (ie the edge of the paper was covered in gold leaf, like you might see on a church bible).
Basics of Gilt Investing
Gilts, like other bonds, pay a set return (known as the coupon) for a set period. Therefore it is easy to work out what return you expect to get on gilts.
More than that, because they are issued by the UK Government, which has never yet defaulted on its debt, your return is very secure. You are almost certain to get your money back. This is as safe a bet as there is in investing.
However, because of this low risk, lots of people are willing to (or in the case of insurance companies, pretty much have to) invest in gilts. That means that the return you get is low as well.
This is one of the basic ideas in investments: if something is low risk, then it will have a low expected return (assuming that it has been valued properly by the market).
Inflation and Gilts
Unfortunately, there are still some risks to investing in gilts. The biggest of these is inflation risk. If inflation is higher than expected then even when you get your money back as expected it will be able to buy less of what you want and need. This is clearly not such a good deal.
Fortunately, there is a solution to this problem, the UK Government issues index-linked gilts. These are linked to the UK Retail Prices Index (RPI) measure of inflation which offers you some protection against inflation shooting up and eroding the purchasing power of your investments.
However even this is not perfect as "your inflation"—the rate at which your costs go up, may not be the same as RPI which is based on the economy as a whole.
The "Risk-Free" Asset
Government bonds from major developed countries, like gilts, are sometimes called "risk-free" assets. No investment is truly risk-free but these bonds are probably as close you can get in real life.
The yields on index-linked gilts are used by investment professionals as a benchmark for many things, because it is the closest thing you can get to a theoretical "risk-free yield on top of inflation". In theory, the expected return on risky assets like shares should be higher than this because of the extra risk involved. However, remember that just because the expected return is higher doesn't mean it will be every time you invest—that's why they are called risky assets!—but that it should be higher, on average, over a longish period of time.
The other risk for investors in gilts doesn't come from the gilts themselves. It's what investment professionals call "opportunity cost". This is the risk that by investing in gilts you are missing out investing in something more suitable. This is why you need to think carefully about what your investment needs are and what products are suitable. There is no one right answer for every person. It will depend on how much investment risk you are willing and able to take and what sort of income you might need from your investments in the future.
You can buy gilts directly from the government agency that issues them (the DMO) or via a company providing gilt funds. Income from gilts is taxable, so you might want to consider buying them via your ISA if you are eligible. If you are buying them for your pension, you should make sure your investments are properly transferred to your pension plan, so that you don't pay tax on them unnecessarily.
Other Asset Classes
To make sure you don't miss out, you should also consider investing in other asset classes. Different asset classes have different features and you might find a mixture can help to meet your individual investment goals.
As a retail investor in the UK, you may also be able to invest in National Savings and Investments products like "index-linked saving certificates". These are generally only available for short and medium-term investments (unlike gilts) but are easier for a retail investor to buy and hold directly.
Summing it All Up
Like all investments investing in gilts involves risks, risk from inflation and risk from missing out on other opportunities.
Do your research, take independent advice if you think you need it and make sure you understand how you are investing and why. And good luck!
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2014 Cruncher