15 Mar 2025
Many UK Government bonds, or gilts, are currently trading below their nominal value. High earners can benefit from attractive after-tax yields, thanks to tax-free capital gains. Lumin Wealth’s Managing Director, Martin Cotter, explains more.
A conventional gilt (UK Government bond) is a type of debt security whereby an investor lends their money to the UK government.
In return, they receive a regular interest payment, in addition to the face value of the capital when the bond matures. Gilts are considered to be risk-free, as they are fully backed by the UK Government.
Buying gilts amid the current interest rate environment can be a cost-effective – and potentially lucrative – investment strategy. However, with the Bank of England (BoE) opting to cut interest rates on February 6, and further cuts potentially on the horizon, this investment ‘window’ may not be open for long.
How are gilts issued?
Most gilts are issued at a price of £100, known as the par value (or face value), which is the amount you receive back at the end of the investment. Gilts are available at a range of different maturities from a few months to around 50 years. The return on a gilt is made up of two sources: the coupon/interest payment and the gain or loss from any movement in price.
High interest rates boost value-add of gilts
The Bank of England hiked interest rates from end-2021 in an effort to combat inflation.
These official rates affect bonds as the Government needs to pay more on new borrowings (‘debt issue’). Bond prices are inversely related to yields, so when new debt is issued at higher rates, existing debt sells at a lower price to maintain a competitive yield.
As a result, many gilts are trading below their par value of £100, providing an excellent opportunity for potential investors. Gilts trading below par benefit from what is known as the ‘pull to par’ effect, with the price moving towards £100 as the bond approaches maturity. All other things equal, the lower the coupon on a bond, the further below par it will be trading.
For individual investors, the coupon is treated as income, while the pull to par is a gain. The tax advantage of investing in gilts is that they are completely exempt from capital gains tax (CGT), which is particularly useful for higher and additional rate taxpayers who normally pay CGT at a rate of 20 per cent on their taxable gains.
Purchasing a gilt with a low coupon and bond price means the majority of the return comes from the gain component, enhancing the tax benefit.
As the illustration shows, investing in a gilt compares favourably with putting money into a fixed-rate savings account, where the income is taxable.
Added diversification
An investment in gilts can provide a diversified source of return in a portfolio. They often move in the opposite directions to equities, and deliver smoother, more predictable returns.
Bonds can perform well in times of uncertainty, such as an economic contraction or general ‘flight to safety’ in markets.
This opportunity may not be around for long, however. With inflation largely tamed (although still above the BoE’s long-term 2 per cent target), market participants expect the BoE to cut interest rates further over the coming months, and for bond yields to decrease.
Longer maturity gilts are more sensitive to changes in interest rates, so it may help to spread the investment across a range of maturities to diversify the risk.
It helps to speak to a financial adviser when considering a new investment to assess the impact on individual goals or your risk profile. In general, gilts should only constitute a limited portion of your investable assets.
Investing in gilts is typically suitable for higher net worth individuals with substantial capital. Want to find out more? Get in touch with our team on 03300 564 446, or use our contact form.
