Gilts – Opportunities at the Shorter End
Lewis Brasseaux at Aspen Advisers explains:
The UK gilt market has long been an asset class favoured by more cautious investors and as a mainstay in portfolios to help balance risks elsewhere. It also delivered a long period of capital gains as interest rates fell and yields moved lower in sympathy. However, gilt yields eventually dropped to levels that meant very little capital upside was left and losses highly likely when yields rebounded. Therefore, when gilt yields started to rise in 2021 and then shot up in 2022, gilt prices fell heavily, leading to large losses and for many who had held them a sour aftertaste.
Although this has left some investors rather wary of the asset class, at current yields and with interest rates on a downward path it is arguably a more compelling investment than it has been for much of the past decade. Yet, the spectre of inflation does linger and Labour’s desire to borrow more to spend more has meant that gilt yields have been more on the up recently.
Nevertheless, not all gilts are equal and those at the shorter end can provide a sensible alternative to standard cash deposits, especially for higher rate taxpayers. The Aspen Gilts portfolio targets low coupon (sub 1%), short-dated (under two years) gilts that are trading below par (100) value. This is with a view to them benefitting from the pull-to-par as they mature – a gain, which is free of capital gains tax.
For example, if a gilt currently trades at 96p, with one year left until maturity, and with a coupon of 0.5%. The return in a year would theoretically be:
• Capital uplift: 96p to 100p, which is free of tax
• Coupon: 0.5%, subject to income tax
At present, the Gilts portfolio offers an average yield of around 4.4%, which has a gross equivalent yield of around 7.4%. Essentially, this is saying that you would need to get in excess of 7.4% in the bank, before tax, to get the same net (after tax) return. The Gilts portfolio also offers daily liquidity, and obviously the gilts themselves are government backed. Given the short-dated nature of the Gilts portfolio, capital volatility is low.
So, whilst the broader gilt market has led to some wilder rides than expected in recent years, investing at the shorter end with current yields where they are, can potentially provide a very attractive tax efficient return.