What are gilts, and are they worth investing in?

Gilts have long formed the backbone of many a private investor's share portfolio.

They are particularly useful for investors who desire a fixed income with a guaranteed return of capital. In fact, some investors believe that the older they get the more valuable Gilts become.

Gilts are about as close to a risk free investment as possible, as they are loans issued by the Government. When issued, the gilt will normally have a nominal (or par) price of £100 against which the "coupon" or interest rate is calculated.

Most gilts are issued for a fixed period of several years, and the market divides the time span into sections. Short-dated gilts are those with a period of up to five years before redemption (the date at which you are repaid), medium-dated are for those between five and fifteen years and above fifteen years, the gilt is known as long-dated. There are also a few undated gilts, which tend to be a purer interest-rate play because they have no redemption date at all - such as the Consols or war Loan. But, for that reason, they can be much riskier in times of rising interest rates.

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Keep an eye on inflation

The coupon that is issued with the gilt is where the interest rate varies with inflation (Retail Price Index). These are called index-linked gilts. Some stockbrokers regard these as a useful each-way bet in the present market. The interest rates on these gilts tend to be lower than those on conventional bonds and according to Barclays Capital, the RPI needs to be over 3 per cent for these gilts to offer a better return than conventional gilts. RPI currently sits at 4.2 per cent.

However, for long-dated gilts higher inflation could mean a reduced income for investors. Government figures on Tuesday of this week showed that the rate of consumer inflation reached its highest level in 13 months, driven by high food and fuel costs.

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How are gilts traded?

Like equities, gilts are traded on the stock market and their price will go above or below the par price driven by supply and demand. Because gilt interest is fixed, their price normally falls when interest rates rise, and vice versa. As rates have been falling for the past 20 years, demand is such that the prices of nearly all gilts are well above par. This spells capital losses for those who hold them to redemption. In other words, if you believe that short-term interest rates are set to fall, then you would be better off by buying a short-term dated gilt as if you are right and rates do fall, then your gilt price is almost guaranteed to rise.

However, you are not guaranteed to get all your capital back under all circumstances, which is why gilts should be seen as investments rather than a form of savings.

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Neil Craze
16 May 2008 © Moneyextra.com

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