A gilt is a bond issued by the United Kingdom government and listed on the London Stock Exchange. The term "gilt" or "gilt-edged security" refers to the fact that gilts are considered very secure investments, as the UK government has never defaulted on payments for gilts.
There are two main types of gilts - conventional gilts and index-linked gilts. Conventional gilts make up the majority of gilts issued and are simple fixed-coupon bonds, while index-linked gilts have coupon payments and principal adjusted for inflation.
Conventional gilts are the simplest form of UK government bond, making up the largest share of gilts in issue. They are a liability of the UK government, which guarantees to pay the gilt holder a fixed cash payment, known as the coupon, every six months until maturity. At maturity, the final coupon payment and principal are returned.
Some key features of conventional gilts:
For example, if an investor holds £1,000 face value of 1.5% Treasury Gilt 2047, they would receive two coupon payments per year of £7.50 each (on Jan 22 and July 22) until maturity on July 22, 2047. At maturity, the original £1,000 principal is repaid.
Unlike the fixed coupon rate, gilt prices fluctuate according to various market factors. Prices reflect the market's view on issues like future interest rate changes, inflation uncertainty, supply and demand conditions.
Yields indicate the actual return an investor earns from buying at the market price. As prices rise, yields fall since investors pay more for the fixed cash flows. Falling prices translate to rising yields.
To generate the same return as a higher coupon gilt, a lower coupon gilt is sold at a lower price. Gilt prices can be calculated using yields based on detailed methods from the UK Debt Management Office.
While the majority of gilts are conventional, index-linked gilts make up a portion of issuance. With index-linked gilts, the semi-annual coupon payments and the principal repayment adjust based on the UK Retail Price Index (RPI) inflation index.
In other words, the coupons and principal repaid adjust to account for inflation accrued since the gilt's initial issue date.
Key features include:
The Debt Management Office provides detailed calculations on determining index-linked gilt cash flows, which can fluctuate as RPI rises and falls.
There are some important gilt market conventions that investors need to understand when buying and selling gilts. These include rules around accrued interest and ex-dividend periods.
Investors buying and selling gilts generally pay or receive accrued interest, which builds up on a daily basis between coupon dates.
For instance, if an investor buys a gilt in August after the July 31st coupon payment, they pay the seller the interest accrued from July 31st to the purchase settlement date in August. This compensates the seller since they will no longer receive the next January coupon payment.
Gilt coupon payments go to holders registered in the ex-dividend period - the 7 business days before the coupon date.
Within ex-dividend periods, sellers receive the upcoming coupon but must pay part of it to buyers as rebate interest. Buyers aren't entitled to the upcoming coupon but receive rebate interest after purchasing.
While gilts share similarities with other fixed income products like corporate bonds and municipals, there are some key differences:
Gilts offer very low risk returns suitable for conservative investors. Corporate and high yield bonds pose higher risk but yield higher returns. Municipality debt offers tax advantages but has greater risk than gilts.
Gilts can play an important role in a balanced portfolio as a low risk option for fixed income allocation. As the safest bonds issued within the UK market, gilts provide stability but yields remain relatively low.
Understanding the different types of gilts, pricing mechanics, market conventions and comparisons to alternatives aids informed investment decisions. Whether utilizing gilts for stability, hedging inflation with index-linked gilts or pursuing higher returns through corporates, they provide an integral tool for laddered bond portfolios.
Meow makes it easy to purchase Gilts for businesses, custodied at BNY Mellon Pershing through our infrastructure provider.