What Are Gilts?

Meow Advisory, LLC

Meow Advisory, LLC

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

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:

  • Denoted by coupon rate and maturity date (e.g. 1.5% Treasury Gilt 2047)
  • Coupon rate reflects market interest rates when first issued
  • Wide range of coupon rates reflecting interest rate fluctuations
  • Coupon indicates cash payment per £100 of face value per year
  • Traded in units as small as one penny
  • Payments rolled to next business day if due date falls on a non-business day

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.

Conventional Gilt Pricing & Yields

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.

Index-Linked Gilts

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:

  • Denoted by coupon rate and maturity (e.g. 0.125% Index-linked Gilt 2039)
  • Coupon reflects real interest rates at issuance
  • Coupon indicates cash payment per £100 nominal adjusted for RPI inflation
  • Payments differ in size based on inflation between coupon dates
  • Principal at maturity also adjusted for total accrued inflation
  • Cash flows can fall if RPI declines

The Debt Management Office provides detailed calculations on determining index-linked gilt cash flows, which can fluctuate as RPI rises and falls.

Gilt Market Conventions

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.

Accrued Interest Convention

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.

Ex-Dividend Periods

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.

Key Differences Between Gilts and Other Fixed Income Securities

While gilts share similarities with other fixed income products like corporate bonds and municipals, there are some key differences:

  • Gilts are issued by the UK government rather than corporations
  • Considered lowest credit risk/virtually default-free
  • Liquidity may differ from smaller corporate bond market
  • Tax treatment varies - municipals offer tax-exempt income

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.

Conclusion

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.


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U.K. Gilt pricing quoted net of fees. ~5% U.K. Gilt yield is sourced from Investing.com December 2023 6-month United Kingdom 6-Month Bond Yield. ~5% Treasury Bill yield is sourced from treasurydirect.gov December 2023 12-week U.S. Treasury Bill auction.

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