British government bonds, long known as gilts, are perhaps the safest of all investments. While government bonds in some countries aren't altogether safe, no British government has ever defaulted on a bond payment of interest or principal.
Bond profits
The return from owning a gilt, like any bond, is a combination of income and price. There is an inverse relationship between those two, so higher bond prices mean lower income and vice versa. Let us say a bond offers a 3 per cent coupon, which means £3 on every £100-worth. If that bond is available at £90, that means the actual yield to the buyer is £3/£90 = 3.33 per cent. Moreover, holding the gilt to maturity will add an extra gain of £10 in price. These two figures are combined to calculate a gross redemption yield. Conversely, take the Treasury 4.75 per cent 7 September 2015. This is priced at £112.7 so the income yield is 4.22 per cent. However, once you factor in the capital loss by the repayment date, the gross redemption yield (GRY) comes out at 2.21 per cent. Needless to say it is very important to consider the GRY given that most gilts are held to maturity, rather than being actively traded.
How to buy
Gilts can be bought through a stockbroker just like shares, except there is no stamp duty on purchase. There is no capital gains tax on gilts for UK residents, but losses on them cannot be offset against tax either. However, the income is taxable, which is why it might make sense to protect that income in an individual savings account (Isa) or a self-invested personal pension (Sipp). Only gilts with five years or more to run are eligible for an Isa, but any gilt can be put into a Sipp.
What to buy
An investor new to gilts might be baffled about which issue to buy. There really isn't any brokers' analysis available to retail investors. Indeed, there might not seem to be the need, given the slightly sedate feel of the market. To a casual observer, conventional (non index-linked) issues do seem fairly similar with just slight increases in yield offered as the duration increases. In reality, returns can vary considerably over the life of a bond, and the stock to choose depends upon your own tax status. Non-taxpayers or those whose holdings will comfortably sit in a Sipp or Isa may be quite happy to take all their return in income. However, higher-rate taxpayers with substantial holdings will almost certainly want to take advantage of the CGT exemption by taking their return in price gain. See our cover feature on page 16 for gilt recommendations.
Gilt funds
For investors who don't want to get into the nitty gritty, there are plenty of fairly cheap gilt tracker funds and exchange-traded funds. The iShares FTSE All Stocks Gilt Exchange Traded Fund offers a total expenses ratio (TER) of 0.2 per cent and a GRY of 2.85 per cent. It has returned 20 per cent since the start of 2007.
| Index-linked gilts |
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An index-linked gilt should be the superman of all bonds; protection against the green kryptonite of inflation that eats away at returns on conventional issues. However, the returns from index-linked bonds start much lower than those of conventional issues, and you typically need inflation to be at least 2.5 per cent to match the returns from ordinary gilts. A nominal £100 of the 0.5 per cent Treasury index-linked stock due 2050 will be worth £334 on redemption if inflation is 3 per cent, but the figure falls to £275 at 2.5 per cent inflation. If you have a large portfolio of conventional gilts, it would make sense to have some inflation insurance by owning linkers, as they are known. But how much? Linkers make up less than 20 per cent of institutional gilt holdings, even in pension funds that have real worries about future liabilities, so a smaller proportion would be enough for an individual. |
