Is investing in gilts the key to a golden future?

As storm clouds brew over the economy, it is hard at first to spy a silver lining. Interest rates were hiked to a 15-year high of five per cent by the Bank of England on Thursday, piling further pressure on millions of mortgage holders and other borrowers. Inflation remains stubbornly high at 8.7 per cent, squeezing household budgets ever tighter.

But there is one ray of light for investors seeking out an income.

Investors who buy UK Government debt – known as gilts – are in line for a bumper income, the likes of which has not been offered since 2008.

Some gilts are now paying out over five per cent. And the longer inflation and interest rates remain elevated, the higher gilt yields are likely to rise.

But buying UK Government debt is not for everyone. Here’s how to work out if it’s right for you – and how to get stuck in.

Treasure chest?: Investors who buy UK Government debt – known as gilts – are in line for a bumper income

WHAT ARE GILT-EDGED SECURITIES?

A gilt is an IOU note issued by the Treasury, promising you regular interest payments in return for lending the UK Government your money for a set period. You are also promised the return of your initial investment at the end of the lending period.

The word ‘gilt’ is short for ‘gilt-edged securities’, which is what they were originally named because the first certificates issued by the British Government to bondholders had gilded edges.

Gilts are seen as low risk because investors are almost guaranteed to get their money back. The UK Government has not once defaulted on its debt despite a very long track record. It has been issuing gilts since 1694 when King William III raised £1.2 million to fund a war with France.

The popularity of gilts has been growing as yields on this historically-safe asset rise. Some now pay a higher income than can be achieved through savings accounts.

Jason Hollands, at investment platform BestInvest, says: ‘My message to investors who have not given much consideration to bonds in the past is that bonds are back in business and should now be on their radars again, given the yields now available.’ However, you need to research exactly what you are investing in before you buy.

Although the word ‘gilt’ technically only applies to debt issued by the UK Government, sometimes it is incorrectly used more loosely to describe debt issued by other countries and even by some companies that are seen as very creditworthy.

James Carthew, at investment research group QuotedData, says: ‘Banks have been slow to pass on higher interest rates to depositors, so it is not surprising that investors have been turning to the next best thing – short-term gilts.’

WHAT INCOME COULD YOU GET INVESTING IN THEM?

In general, the longer you agree to lend your money for, the better yield you will be offered. That is because you as the lender are taking on more risk by tying up your money for longer. However, this rule does not always hold true. At the moment, gilts that mature in two years’ time pay out a yield of 5.13 per cent.

The yield on a five-year gilt is currently 4.54 per cent, on ten-year gilts 4.30 per cent and 30-year gilts pay 4.43 per cent.

HOW CAN I GET A HIGHER RETURN?

If you want a higher, fixed income from your investments, you will have to look for debt issued by other governments or companies. As a rule of thumb the better the yield, the more risk you will be taking on.

Some investment companies that invest in corporate debt are yielding eight or nine per cent. For example, CQS New City High Yield Fund and TwentyFour Select Monthly Income. However, these funds often invest in companies with low credit ratings so there is a greater chance that you will not get your money back than with bonds issued by blue chip companies or solid governments.

Other countries also issue IOUs, although they go by a different name to gilts. However, by comparison gilts are currently some of the highest-yielding among other, stable governments. The US government sells Treasuries. These are currently yielding around 3.8 per cent on debt that matures in ten years. The German government has bunds; these are yielding 2.5 per cent for debt issued over ten years.

WHY ARE YIELDS ON DEBT RISING?

The yield that the UK Government pays on its debt is determined by how much it needs to offer to convince investors to buy it.

When interest rates rise, investors need more persuading to buy gilts. That is because higher rates mean investors can get an increasingly good income simply by leaving their money as cash in a savings account – they don’t need to bother investing it at all.

The greater the perceived risk that a borrower could default, the more it has to pay to lenders to take on its debt. Therefore, in times when a country or a company is struggling, or when investors lack confidence in the people at the helm, their cost of issuing debt rises.

However, in the case of UK and other strong governments, credit risk has a very modest influence on the price of debt simply because they are seen as such reliable borrowers.

WHAT ARE THE RISKS OF PUTTING MONEY IN GILTS?

WHEN gilt yields rise, their price falls. That is good news for investors buying gilts now as they are very cheap. But it’s not so good for investors wishing to sell existing gilts. If yields continue to rise, you may find that if you later decide to sell your gilts the price you get for them will be less than the price you paid for them.

There is always a risk when buying debt that the issuer might simply become unable to pay you back and you will lose your investment.

This is extremely unlikely with UK gilts, but other governments, such as Argentina, Lebanon and Ukraine have defaulted, resulting in investors losing money. Be aware of the risk when you buy any government or corporate debt.

One good way to measure the risk is looking at ratings given by specialist ratings agencies such as S&P, Moody’s and Fitch. These estimate the default risk for lenders, and rate them from AAA – the safest – to BBB and even D for some agencies.

You can manage your risk level by only buying debt with ratings that you feel comfortable with. If you do decide that gilts are right for you, they should only form a part of your portfolio, along with other types of investment so that you don’t have all of your eggs in one basket.

Although yields on gilts have risen, they are not outrunning inflation so if you have all your money in gilts, it will diminish in value over time.

However, it is hard to find any investments that beat the rate of inflation at the moment. Any that do are likely to be considerably higher risk than gilts.