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Bonds: Investing in gilt funds

INVESTMENT GUIDE: Gilt funds may seem slightly redundant, but they should not be dismissed out of hand.

Investing in a portfolio of investments means that if one goes wrong, all is not lost. So buying a fund that invests in gilts - pretty much the safest investment there is - may seem a little odd.

But, the returns that gilts offer can depend on interest-rate movements and inflation. If you buy just one or two long-dated gilts, for example, and interest rates move against you, then your returns could be hit hard. Investing in a fund protects you against this hit. This is because the fund manager can actively manage duration risk: the sensitivity of the portfolio to interest rate movements, by investing in a range of long, medium and short-dated gilts.

"In practice, it's quite difficult to call it [the impact of rate movements and inflation] right, and it's rare for these funds to beat their benchmarks." This is clear when looking at the table of all UK gilt funds below. Performance differs dramatically, as do the yields. One problem is the management fees that these funds charge, which at 0.75 per cent to 1 per cent a year can seriously compromise returns.

One answer is to invest in a tracker, which tend to produce better returns - Scottish Widows runs a conventional gilt and an index-linked gilt tracker, both with an annual management charge of just 0.25 per cent. An attractive alternative is the iShares FTSE All Stocks Gilt Exchange Traded Fund, which has a total expense ratio of 0.2 per cent and a gross redemption yield of 5.34 per cent.