- The Treasury has launched a new gilt offering 5.375% interest until January 2056
- Gilts are growing in popularity among retail investors as they look for alternatives to cash and for investments with tax benefits
- How gilts work and what to consider when investing in gilts
- How to participate in a new gilt issue as a retail investor
“Investors are being given the opportunity to buy a UK government bond, known as a gilt, offering the equivalent of 5.375% interest every year for the next three decades,” says Dan Coatsworth, investment analyst at AJ Bell.
“At the end of that period, you will get back the face value of the bond and will have enjoyed a steady stream of interest payments. While that might sound enticing, deciding if the investment is attractive is not as straightforward as you think.
“In the current market, 5.375% equivalent interest could have investors jumping for joy. A bank offering that rate on a cash savings account might have a long line of people queuing up to hand over their money. The rate is much higher than the current best-buy cash deals on the market for instant access and five-year fixed rate savings and it’s also more generous than the 3.3% prospective dividend yield on the FTSE 100.
“So, what’s the catch with the gilt? If interest rates go up, gilt yields could also move higher. That means future gilt issues could have a more attractive headline yield and investors might sell their existing gilts to buy the newer ones. That process could push down the price of existing gilts.
“This wouldn’t matter to anyone intending to hold a gilt until maturity, as they would be repaid the original face value of the government bond. However, an investor would need to be prepared for movements up and down in the gilt during its lifespan in line with changing interest rate expectations. That means someone holding to maturity should buy and forget rather than regularly checking the price in the way they might do for stocks and shares.
“Inflation also matters when weighing up gilts. Gilt prices tend to fall when inflation rises by more than expected because investors tend to demand a higher yield to compensate for the erosion of the investment’s value and purchasing power.
“Some people might think they can easily make in excess of 5.375% a year through investing in the stock market. While that is true, investing in stocks and shares comes with much higher risks than investing in gilts.
“Anyone interested in taking part in the gilt offer needs to get their skates on. On the AJ Bell platform, orders need to be made by 2.30pm on Monday 19 May, with Wednesday 21 May being the first day of trading. After that point, there should be a secondary market in the gilt, but liquidity is unknown. The first interest payment will be made on 31 July 2025 and the gilt will mature on 31 January 2056.”
Why are gilts growing in popularity?
“Gilts have become popular over the past few years among retail investors, including AJ Bell’s DIY investor customer base. That’s partially down to greater retail investor access to gilt offers and also because of shifts in the market backdrop.
“The rapid rise in the Bank of England’s base rate in 2022 and 2023 to cool the rate of inflation made cash an attractive place to earn a decent return. That dynamic is now fading away as the Bank of England has begun a journey to cut rates. Interest rates on cash savings have slowly been coming down since summer 2024 and that’s prompting savers and investors to look at alternatives to cash such as gilts.
“Gilts have also appealed to investors who have used their annual ISA allowance – they’ve been buying gilts with the hope that prices go up and they can make a quick profit. Gilts are advantageous because you don’t pay any tax on capital gains.
“AJ Bell has also seen a rise in advisers recommending gilts to clients. This is primarily due to them becoming highly tax efficient investments in recent times, particularly for higher and additional rate taxpayers given any gains made on gilts are exempt from capital gains tax. With some gilts trading below ‘par’ (£100) and offering a low coupon, it means that a good proportion of the return, if held to maturity, comes from capital gains rather than from income. As a result, when the yields on offer are held up next to the interest rates available on deposit, gilts compare very favourably when focused on the short-dated part of the market .”
Why is the market expecting an increase in gilt issuance?
“Governments issue bonds as a way of raising money. Last October, Chancellor Rachel Reeves announced a series of tax-related changes and efficiency drives in government to strengthen public finances, while also pledging to spend money in certain areas such as to improve the country’s infrastructure.
“Many of the tax initiatives and efficiency drives won’t provide an immediate boost to public finances, which means the market is braced for an increase in gilt issuance as a way for the government to access more funds.”
Gilts explained
What is a gilt?
“In the simplest of terms, a gilt or bond is an IOU.
“By buying the bond, the investor is effectively lending money for a pre-set period to a borrower, be it a government, a company, or a supranational entity such as the European Investment Bank. In return, the borrower pays interest – the coupon – and then at the end of the bond’s pre-determined lifespan repays the initial investment, known as the principal.
“The advantages of this are the buyer knows exactly what coupon (and thus yield) they will get over the life of the bond and that they will get their money back at the end, barring some unexpected disaster.
“Gilts may appeal to income-seekers. However, there are still some dangers of which patient portfolio builders should be aware, so they can factor them into their study of whether the coupon on offer is sufficient to justify these risks and that the instrument’s return profile fits with their overall investment strategy, target return, time horizon and appetite for risk.
“With bonds, there are four risks that investors should consider, although if the investor’s plan is to buy on issue and hold to maturity then the relevance of some will be greater than others.”
- Credit, issuer or default risk
“This is the likelihood of the issuer defaulting on its debt, either because it cannot afford to pay the interest (coupons) or repay the loan (principal) upon maturity. Were this to happen the price of the bond would collapse and wipe out the benefit of many years’ patiently accrued coupons.
“The UK should not provide undue concern here, even if its public finances are far from pristine, as evidenced by the Chancellor of the Exchequer’s fight to meet her own fiscal rules and persuade bond markets the Labour government is a sound steward of the national debt and its economy. If push comes to shove, the UK can always print more money to meet its liabilities, while the last time the UK defaulted was the so-called Stop of the Exchequer under King Charles II in 1672.
“Perhaps a greater danger than default is the UK’s need to sell ever-greater sums of gilts, via the Debt Management Office (DMO), which means investors demand higher yields for future issuance, making this 31-year gilt look potentially less attractive than future ones.”
- Liquidity risk
“It is important to make sure the gilt’s issue size will be large enough for investors to easily buy and sell in the secondary market, should they suddenly find themselves in need of cash.”
- Interest rate, or market, risk
“If interest rates rise, either because inflation gallops higher or markets fear the government is doing a poor job of managing the nation’s finances, gilt prices generally fall as holders sell existing positions to buy new positions in new issuance, which will have to come with higher rates to compensate for advances in headline borrowing costs. Price changes can then erase a chunk of the income accrued, if the holder finds themselves a forced seller for any unexpected reason.”
- Inflation risk
“This is perhaps the biggest danger of all, especially if the investor is planning to hold the gilt for its entire lifespan. The annual rate of inflation in the UK, according to the Office for National Statistics’ monthly consumer price index calculation, is 2.6%. This new gilt’s coupon is 5.375% (and the yield upon purchase is likely to be pretty close to that) and that equates to a real, post-inflation return of 2.775% a year, assuming the gilt price is in line with £100 par upon issue. However, if inflation starts to gallop then those real returns are eroded. In a worst-case scenario, the investor would start to be worse off in real terms if the annual rate of inflation exceeds the 5.375% coupon on the gilt.”
What’s the difference between ‘coupon’ and ‘yield’?
“The coupon on a gilt is usually pre-set, as is the lifespan of the instrument – hence the name ‘fixed-income.’
“However, the yield upon the gilt can and will differ from the coupon, because the price of the gilt can and will change during its life, even if it will be redeemed at par of £100 upon maturity.
“The coupon, in this case 5.375%, refers to the yield implied by issuance of the gilt at par, or £100.
“The flat yield – also known as the simple, income, running or current yield – on the paper is calculated by dividing the gross annual coupon by the market price of the gilt. Thus, if the price were to zoom to £110, because inflation eases and interest rate expectations fall, then the yield on the 2056 gilt would retreat to 4.88% (5.375 divided by 110).
“The gross redemption yield adjusts the yield for any capital gain or loss implied by the current market price of the gilt.
“The net redemption yield is calculated by assuming that the holder pays tax on the coupons received. In this example, someone in the 40% income tax bracket would thus get an annual coupon of £3.225p for every £100 gilt owned and that equates to a net redemption yield of 3.225% upon the maturity price received of £100.”
How to participate
New issue gilts are managed through either an auction or a syndicated process which is run by the UK Debt Management Office (DMO).
- In an auction, investors can bid for whatever yield they choose and depending on the yield they bid, they may receive none, all, or some of the gilts they request. An auction results in an average yield and an average price. The average price is the price that retail investors pay in an auction.
- In a syndication, investors tell the DMO what yield they expect for the maturity on offer. This results in market-clearing yield (and a market-clearing price) for the gilt. The market-clearing price is called the “re-offer” price and this is the price that all investors pay.
This new 5.375% 2056 gilt will be syndicated – how does this work?
Prior to the date of the syndication (the day the gilt is priced and allocated to investors), investors will know the duration and coupon associated with the gilt, but not the issue price. Retail investors will bid (apply) for a monetary value of bonds during the application window, which lasts around six days and closes one day prior to the auction. Gilt syndications are extremely competitive with tight spreads, ensuring that retail customers will receive a fair price.
Customers of AJ Bell can apply through their account and will receive an email if they’re opted in to new issues and IPO offers.
From there, they can place orders for the new gilt online and will be asked to submit an order to invest an amount of cash. We then submit orders to the appointed debt dealer.
Is there a minimum investment?
The minimum investment is £1,000.
What’s the dealing charge?
There is no dealing charge.
