A confluence of factors shows signs of increasing the demand for UK short-dated gilts in retail investor portfolios. Here’s what you need to know.
The UK Government issues a range of types of bonds to investors. These can, and do, include anywhere from one to 50-year bonds, called ‘gilts’ in the UK context.
When interest rates are low, as was the case for around a decade after the 2007-08 Great Financial Crisis (GFC), the incentive for the Government was to issue more longer-dated gilts at lower interest rate levels.
However, as rates have soared post-Covid, the Government has increasingly considered issuing more short-dated gilts (typically under five years to maturity) to decrease their longer-term exposure to higher rates.
When rates begin to fall, as is happening now, shorter-dated gilts are also preferable because when the Government then refinances, it should find its borrowing costs reduce more quickly.
However, there has been a notable trend in recent years as more private or ‘retail’ investors (as opposed to institutional investors such as banks or asset managers) have started to buy short-dated gilts in larger numbers. Why is this? There are a few reasons.
Better rates
More retail investors have bought what are deemed ‘ultra short-dated’ gilts – these are typically under three years to maturity – because they represent better value for money in terms of the interest payment.
Savings account rates from banks and building societies have improved, but many of the biggest banks still offer desultory rates on their savings products. Investors, quite simply, can get a better return on their money in short-dated gilts.
Although these gilts do carry more risk than a savings account, because they are issued by the Government, their relative risk is still low (compared to, for example, equities).
Changes to ISA rules
Another more recent change appears to be driving some new investing into the short-dated gilt market. This is the recent change to ISA rules designed to lower the amount of money savers hold in cash ISA accounts.
The limit one can save into a cash ISA will be lowered to £12,000 from the new tax year (2026-27). This means more cash has to go toward a stocks and shares ISA. But if the saver does not want the higher risk associated with equities, then short-dated bonds are a good proxy for savings.
Capital gains tax efficiency
Finally, perhaps forgotten all too readily, short-dated bonds do come with some tax-efficient benefits (which further neutralises the cash ISA cut issue).
Short-dated gilts are exempt from capital gains tax (CGT). This is quite a potentially beneficial savings method then for those who are unable to save more within an ISA in a tax year.
It is important however to be aware that there is an exhaustive list of which gilts are exempt from CGT. To benefit from the exemption, the short-dated gilt must be on this list.
What should I do?
If you are interested in the area of short-dated gilts, then there are a few things to be aware of.
First, as mentioned above, it is important to ensure you’re investing into the correct instrument in order to avoid an unexpected tax bill.
Buying short-dated gilts is also a trickier process to get right than saving straight into a consumer-friendly savings account. In particular the nomenclature of such assets can be confusing and investment platforms often don’t help much.
Finally, buying gilts has inherent risks that need to be properly understood. Gilts have a yield on offer, but the prices of those gilts fluctuates with the market.
If it is an area you are interested in considering then it is vital to consult with a qualified financial planner. A planner can help you to establish whether this is the right approach for your long-term plans, or if your money might be better suited elsewhere.