I don't understand gilts

[butteredcrumpetz]

I've read websites and listened to podcasts but still don't fully understand gilts. In particular, I don't know how to look at a list of gilts like the one shown below (from Hargreaves Lansdown) and determine which are worth buying and which aren't.

For example, if I buy the one at the top of the list for £106.40, and keep them to the maturity date on 7th Dec 28 will I get:
a) £106 (6% on the original issue price)
b) £112.78, (6% on my purchase price over 3 years)
c) £119.10 (6% compound interest on the original issue price over 3 years)
d) £126.72 (6% compound interest on my purchase price over 3 years)
e) Something else?

Also, if gilts are considered relatively low risk, why is the Vanguard UK Gilt UCITS ETF labelled as risk level 5 (out of 7)?

I agree, Gilts are confusing!

For the individual gilts, you get back the original capital sum, plus interest (coupon payments along the way). The face value of a gilt is always 100. The 106 is what I believe is called the 'dirty' price, i.e. the price you pay to by the gilt on the secondary market. So you'd be paying more than the face value of the gilt in order to get just under 4 years' worth of interest payments (6% per year), plus 100 returned as capital when the gilt matures. This is because prevailing gilt yields for the term of the bond are currently around 4-4.5%, so what you get back should be around that amount, annualised. Meanwhile, the price of the gilt will move around, but if you hold to maturity you know exactly what you're getting back as capital and interest.

In some cases you'll see that the coupon payment is much lower than 6%, sometimes below 1%, because those gilts were issued at a time when interest rates (and gilt yields) were near zero. You can buy those for less than 100, so that, again, your returns come to the same as the current prevailing gilt yields. So you might get back, say, 5% as capital (the difference between, say, 95 and 100), and the rest as lower coupon payments. A lot of investors like low coupon gilts because any capital gain is tax free, while coupons are subject to income tax over your savings allowance. Other investors prefer higher coupons because they want the regular income.

There are gilt return calculators online which you may find helpful, and Investopedia provides a basic explanation of how gilts work.

There are also index-linked gilts, which return a fixed amount plus inflation, but these can behave very differently, so I don't recommend them if you are just starting out.

The reason a bond fund, like the Vanguard one, is at risk level 5 is because, unlike a single gilt, where you know exactly what return you are getting, the gilts held in a fund will be maturing at different times, meaning that the value of the units in the fund will fluctuate, and it isn't possible for an investor to sell out with any certainty of return. Bond funds fell very sharply a couple of years ago when interest rates starting going up. But anyone holding a gilt would have been fine, as long as they waited until it matured, when the full capital value would be returned.

@ClematisBlue49 that is a fantastic answer and one of the reasons why I love MN!

Thanks @ClematisBlue49 , that's helpful. On the back of your post I googled UK gilt calculators and found found this very useful MSE guide, which explains how gilts can be used tax efficiently. https://www.moneysavingexpert.com/savings/uk-gilts-lower-tax-savings/

Thus definitely fills in a few gaps in my knowledge.

Good explanation by @ClematisBlue49, but one slight error

Bonds prices on the open market have a 'clean' price and a 'dirty' price. The clean price is the price without any accumulated coupon (i.e. interest). The dirty price takes into account accumulated coupon. You will always pay the dirty price

UK gilts are not really a great investment - the yield is generally around what you can get in interest from the best high street accounts. They do have an advantage in that they are capital gains exempt, so a low coupon / low price gilt may be suitable depending on your tax position

To answer @butteredcrumpetz's question. If you buy the gilt at the top of the list (Treasury 6% 07/12/2028) at maturity you will receive £100. You will also receive £3 every six months in income until maturity (gilt coupons are paid twice a year)

@butteredcrumpetz another thing I have just remembered. You will often hear people talk about the "yield" of bonds. This is a function of the coupon, price and time to maturity. So if you bought "Treasury 6% 07/12/2028" today at £106.40 the yield would calculate as 3.99% - which broadly equates to sticking your money in a savings account with an APR of 3.99% (ignoring tax)

I’ve been pondering a gilt ladder for income from 2028-32 as opposed to using a short term money market fund, which I’m currently building as a ‘pot’ within my Sipp.
If interest rates drop below 3.5% then the gilt ladder, paying an average 4.2% ( according to the confusing calculator I used) obviously wins but I can’t work out how much better off I’ll be, the calculator deducts tax which isn’t relevant to a Sipp for one thing.
It’s also a faff, buying 5 different gilts that mature in 5 different years. I’m not sure I actually trust this Government either, although if they default on debt then we’re all up shit creek anyway.
Interest rates could also rise again over the next 3 years, despite the ‘predictions’.
I think I’ve talked myself out if it 😂
I might just buy a 2031/32 gilt just to see what happens.

I have a couple more questions.

I've gone through all of the gilts listed on Hargreaves Lansdown and fed them into MSE's calculator..None of them beat current high street lending rates. The best gave an overall return of about 2.5%, and only if kept to maturity, so would be locked away for about 20 years. So first question is - why would anybody ever buy gilts from that list?

Then I searched for best gilts, and saw a couple of tables of "most popular" gilts, which were different to the gilts in the HL list. So my question is ... why does HL not list the "most popular" gilts on their site? e.g. Is it because they can only bought from certain providers and, if so, why?

2.5% sounds wrong to me. Try this calculator:

https://www.dividenddata.co.uk/bond-yield-calculator.py

I ran a couple of examples, maturing in 2028 and 2030, and the yield was just over 4% (including both capital return and coupon).

Many people will opt for a Gilt with a coupon below a typical savings rate for tax reasons. The savings tax allowance for most people is £1,000 (£500 for higher rate tax payers I believe), and once you have savings over a fairly modest amount, the tax (charged at your marginal income tax rate) has a significant impact on real returns (i.e. the interest payment less inflation). If you're getting about 4% from a Gilt, but a chunk of that return is a capital gain, which is tax free for Gilts, then they will look more attractive than a savings account paying a bit more than 4%.

Also, just to note that with a Gilt, you're not locked in. Unlike a fixed rate savings account, you're free to sell at any time. Under some circumstances (Gilt yields suddenly plummeting, meaning that the capital value shoots up) it can make sense to sell early. But you only get the expected return if you hold to maturity.

I can't answer your 2nd question, I'm afraid, as I've only bought Gilts on HL.

@butteredcrumpetz what is the link to the MSE gilt calculator you have used? 2.5% seems not right

Current yields to maturity for gilts are around 4.5%, which is just below BoE base rate. Which is what is to be expected

Here: https://www.moneysavingexpert.com/savings/uk-gilts-lower-tax-savings/

@butteredcrumpetz I have put the numbers in and getting over 4%, as expected

Thanks @MsVisual , I can see the problem. I had navigated via a Google search to this list of "index linked" gilts: https://www.hl.co.uk/shares/corporate-bonds-gilts/bond-prices/uk-index-linked-gilts

I can now see there is a separate list of gilts which includes the one in your screenshot: https://www.hl.co.uk/shares/corporate-bonds-gilts/bond-prices/uk-gilts

I've googled the meaning of "index linked" in this context, so I can now understand why the yields I was calculating seemed low.

It's a shame HL haven't added a yield calculator into an extra column on their list - it would certainly make things easier!

@butteredcrumpetz index linked gilts adds another level of complexity. Calculating the yield on those is more complex (and uncertain as inflation constantly changes)

There are also gilts that pay zero interest called ‘treasury strips’. These can give what look like high yield to maturity on the face of it, but have a complex tax treatment (you pay income tax for each year you hold them)

I suppose one disadvantage compared to a savings account is that the interest on a gilt doesn't compound, yes?

That depends... On HL you can choose whether the coupons are paid out as income or reinvested into the same Gilt. I don't think they charge if you decide to reinvest. If you're holding for a period of years, reinvesting is probably the best way to go, unless you need the income.

The disadvantage with Gilts now is that yields have declined recently, so at this precise moment, savings accounts might be preferable (depending on your tax situation / how much you have in other savings accounts). If you use HL's Active Savings, you might find there are some fixed rate accounts offering better rates if you can move quickly.

I have a fixed rate account about to mature. I had planned to buy another Gilt, but am not so sure now.

OP, look at this website: <a class="break-all" href="https://www.yieldgimp.com/gilt-yieldswww.yieldgimp.com/gilt-yields" rel="nofollow" target="_blank">https://www.yieldgimp.com/gilt-yieldswww.yieldgimp.com/gilt-yields

It shows you the yield of the various gilts, and also calculates it net of taxes.

For gilts with low coupons, most of the return comes from the capital gain, which is tax exempt, so the overall tax will be very low. This is why these gilts can yield more than saving accounts, net of tax - if you have maxed out your ISA and your personal saving allowance.

The Vanguard fund has a duration of almost 9 https://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000WA5Q
meaning it holds long-dated gilts, which are sensitive to interest rates.
You need to familiarise yourself with these concepts. Don't buy any bonds (gilts are bonds) until you do. Basically it means that if rates go up, the price of the fund goes down.

@ClematisBlue49 The reason a bond fund, like the Vanguard one, is at risk level 5 is because, unlike a single gilt, where you know exactly what return you are getting, the gilts held in a fund will be maturing at different times, meaning that the value of the units in the fund will fluctuate, and it isn't possible for an investor to sell out with any certainty of return. Bond funds fell very sharply a couple of years ago when interest rates starting going up. But anyone holding a gilt would have been fine, as long as they waited until it matured, when the full capital value would be returned.

Yes, but it's a bit more nuanced.

If you hold a gilt with a certain duration and rates go up, the price of your bond goes down, but, if you keep it till maturity, you'll get your capital back in the end (this is called pull to par).

If you hold a bond fund with the same duration and rates go up, the price of your bond fund goes down by roughly the same amount. If you keep the bond fund, this will never mature, but will keep rebalancing and buying new bonds.
However, you can sell the bond fund and use the money to buy a set of bonds with the same weighted average duration, keep them till maturity, and this will bring you to roughly the same position as if you had held a single bond above. I say roughly because duration is an approximation.

I’ve never managed to understand gilts either despite lots of googling and reading - thanks to the posters on this thread I finally get it - thank you for posting

Such a useful thread - thank you. I’ve been going down a rabbit hole trying to understand the difference between individual gilts, bond funds and money market funds. In my case as part of a plan to move some current equity investments into something less risky (as I may need to draw in them in the next 3 years).

I did wonder about gilts, as these seemed best suited to my needs of that group. But it all seemed complicated and potentially stressful (at quite a stressful period). So in the end I decided to shift them into a cash ISA with Trading212. The risk there is it having a variable interest rate unlike the certainty you’d have with a gilt, assuming you held it to maturity.