Gilt Funds: Definition, Working, Risk & Returns, And More 

Gilt funds are a type of mutual fund that invests in government-issued securities (gilts). They are a type of debt fund. Government securities are known as gilts as they do not contain default risk due to their sovereign guarantee and rating. Also, they have a low rate of return. However, these bonds are available in the UK, India, and other commonwealth countries. These securities are like US Treasuries.

In this article, you will learn about gilt funds in general and how these gilt funds work. Apart from that, you will also learn about the major types of gilts. Furthermore, we will also discuss some popular examples of gilt funds. Finally, we will look at some of the major advantages and risks associated with gilt funds. Hence, to learn more, read on through to the end of the article.

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What Are Gilt Funds?

According to Investopedia,

“Gilt funds are investment vehicles comprised of gilt securities. Gilts are the U.K. equivalent of U.S. Treasury securities. Gilt funds can be ETFs or mutual funds that invest in U.K. government bonds with the conservative objective of preserving capital. Gilt funds invest in short-term, medium-term, and long-term government securities.” 

These funds consist of government bonds of commonwealth countries. They are pooled investment vehicles that work like mutual funds and ETFs. They are very similar to treasury bonds in the United States. However, they are still attractive investments among many investors despite low returns. This is because these funds do not carry many risks.

These bonds are known as gilt because they have low risk and a low rate of return. Also, the name of these bonds comes from gilded British government certificates back in the day. Furthermore, gilts are also sensitive to big changes in the rate of interest. However, these securities provide ample benefits of diversification. This happens due to a low or negative correlation with stock markets. 

A gilt can be conventional gilt or an index-linked gilt. One can issue a conventional gilt in nominal terms. On the other hand, index-linked gilts are tagged for inflation. Apart from that, gilt-edged securities, which consist of low-risk corporate bonds, are also present. Generally, these also include ETFs or mutual funds that invest in UK government bonds.

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What Are The Types Of Gilts?

As already discussed, gilts are a type of mutual fund that invests in government securities. Governments issue these as debt instruments to generate funds for public expenditure. Also, since they are low-risk investments and have sovereign guarantees and ratings.

Government securities can be of two types – Short-term and Long-term. Short-term securities include treasury bills. These mature within one year, and the central government of the commonwealth countries issue them. On the other hand, long-term securities include government bonds or dated securities. These securities have maturities of more than one year. In this case, too, the central government of these countries issues the securities.

Conventional Gilts

In general, governments issue conventional gilts representing most government debts. They issue these gilts in the national currency. However, they do not make inflationary adjustments. These gilts include nominal bonds. By investing in those bonds, you will get a fixed coupon rate after fixed periods of time (say, six months).  

After the maturity of conventional gilts, the holder receives the principal and the last coupon. Once the government issues a conventional gilt, the coupon rate of the gilt approximates the interest rate of the market. Furthermore, the prescribed maturity dates of conventional gilts are mostly five years, ten years, or thirty years.

Index-Linked Gilts

These gilts include bonds with borrowing rates and principal payments. Here, the latter depends on changes in the rate of inflation. You can compare these gilts to the Inflation-Protected Securities of the US Treasury. However, the first inflation-indexed bonds came out in the year 1981 in the United Kingdom.

In the UK, index-linked gilts make payments through coupons every six months. Apart from that, the payments also include the principal payment at the maturity of the securities. Furthermore, the coupon rates also go through adjustments as per changes in the retail price index of the United Kingdom.

If the government issued a gilt after September 2005, the adjustment of the coupon rates depends upon the rate of inflation three months ago. However, if the government issued the gilt before September 2005, the coupon rates would use the eight-month inflation rate.

Corporate Bonds

Gilts also include low-risk corporate bonds and stocks. These are also known as gilt-edged securities. The term gilt-edge means the security is high quality, and its value remains stable over time. However, one must not confuse gilt-edge securities or private-sector securities with government bonds.

In the UK and other commonwealth countries, corporate gilts are like blue-chip securities in the United States. Credit rating services in the UK rate gilt-edge securities as top securities. However, these bonds’ returns are lower than general speculative bonds. Nevertheless, conservative investors make these bonds the cornerstone of investment portfolios. This helps in the preservation of their capital.

How Do Gilt Funds Work?

Investopedia adds –

“Gilt funds are ETFs or mutual funds that invest primarily in government bonds in the U.K. Gilt funds have the conservative objective of preserving capital. Gilt funds often invest in several different types of short-term, medium-term, and long-term government securities.” 

Hence, you can see that gilt funds are a great option for conservative investors who want a fixed flow of income. However, the value of gilt funds changes with changes in market rates. Generally, with the rise in interest rates, the value of existing bonds falls. Hence, with the fall of rates, the value of bonds rises.

Gilts also trade on the secondary market. This is where the concepts of clean and dirty prices of gilts come to the fore. Investors consider gilt as clean when the price does not consist of accrued interests. On the other hand, the dirty price of the gilt is the total price of the gilt. This includes all prices, including the clean price of the gilt and its accrued interest since the last payment.

Basically, gilt funds are great options when there is a declining interest rate in the economy and the investment horizon is at least 3-5 years. Apart from that, there are also regulations related to gilt funds. They state that gilt funds must invest at least 80% of their capital in government-issued debt instruments.

Finally, as an investor, if you want to invest in gilt funds, you can do so through GEMMs (Gilt-edged Market Makers). GEMM is the primary dealer in gilts. Furthermore, they actively trade in both types of gilts that deal with government securities.

What Are The Examples Of Gilt Funds?

The following are some of the major examples of gilt funds:

1. iShares Core U.K. Gilts UCITS ETF:

According to Blackrock.com,

“iShares offers the widest range of fixed income funds across sectors, regions, and currencies catered to LatAm investors, through UCITS and an extensive US domiciled range of products. […] on average, iShares bond ETFs cost ¼ the price of fixed income active mutual funds.”

These gilts mainly invest capital in UK government securities.

2. Janus Henderson Institutional U.K. Gilt Fund:

They invest mostly in UK government gilt securities.

According to JanusHenderson.com,

“The Fund invests at least 80% of its assets in UK government bonds (also known as gilts) of any maturity. The Fund may also hold other assets including bonds of other types from any issuer, Collective Investment Schemes (including those managed by Janus Henderson), cash and money market instruments.”

What Are The Advantages Of Investing In Gilt Funds?

The following are the major advantages of investing in gilt funds that you will benefit from: 

• Better Liquidity: If you want to invest in government securities through mutual funds, you will not need to worry about liquidity. This is because mutual funds are a type of investment that offers you an easy exit. Furthermore, since your gilt fund portfolio consists of government securities with sovereign ratings, the liquidity is high. It is the highest in gilt funds among all debt instruments. 
• Government Securities: You will find mostly banks and financial institutions among the investors in government securities. However, if you participate in gilt fund investment, you will be able to participate in government securities at a much lower amount. Hence, if you want to invest in multiple government securities at lower capital spending, gilt funds become your best option to choose. 

• Stable Returns: Since gilt funds only invest in government securities, you can ensure their stability. Better Security: Since gilt funds offer you access to the best quality papers, there is no credit risk in them. Furthermore, these securities also offer you a better yield-to-maturity.  
• Better Security: Since gilt funds offer you access to the best quality papers, there is no credit risk in them. Therefore, you will have better security.

What Are The Risks Of Gilt Funds?

There are generally two types of risks associated with gilt funds: 

Default Risk

This is true for any debt instrument. A default risk is the likelihood of a situation where the borrower will not be able to pay the principal and interest promptly and completely. However, this risk is less likely for gilt funds since you get government backing for these securities.  

Here, the government, and hence the security, has a sovereign rating. However, these risks hold true for gilt funds with corporate bonds. 

Duration Risk

Duration risk is the sensitivity of debt instrument prices to changes in interest rates. However, this risk applies to debt instruments with long and higher maturities. The duration risk is the highest for gilts for a longer duration. This is because the maturities of gilt funds, in such cases, range from just ninety days to more than thirty years. Nevertheless, if your goal is to retail the bond to maturity, the risk lessens gradually with time. 

Factors You Need To Consider Before You Invest In Gilt Funds

The following are some of the most essential factors you need to consider before you start investing in gilt funds: 

1. Interest Rates:

You already know that gilt funds invest primarily in government securities. As a result, these funds are sensitive to interest rates, as the latter depends upon the central bank’s decisions. Hence, as interest rates rise, the value of bonds within the fund falls. Therefore, this leads to a decline in the Net Asset Value (NAV) of the fund. Furthermore, when there is a fall in interest rates, the NAV sees a rise. 

2. Investment Horizon:

If you are an investor with an investment horizon from medium to long term, gilt funds can be a good investment option for you. Hence, we do not recommend investment in gilt funds if you do not have such an investment horizon.

3. Expense Ratio:

Investment in gilt mutual funds also comes with operational expenses. As a result, you will also have to pay a charge of expense ratio. Hence, you will benefit by comparing the expense ratios of different gilt funds. This is because expense ratios of gilt funds may differ a lot from each other. 

4. Taxation:

Once you earn profits from gilt funds, you will need to pay long-term and short-term capital gains tax, depending on the fund’s holding period. If you hold profits for more than three years, you will need to pay 20% plus indexation. However, if you hold profits for less than three years, they are subject to normal taxation.

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Wrapping Up

Hope this article was helpful for you in getting a better understanding of gilt funds in general. These funds mostly consist of British government bonds, and they work like ETFs and mutual funds. Since these funds have a sovereign government backing, they are a stable investment.

However, the return is low as it is a low-risk investment. Hence, these investments can be a good option for conservative investors. An investor can invest in a gilt fund through GEMM. Do you have more information to offer on gilt funds? Consider sharing them with us in the comments section below.

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