Like any country, the UK offers investors the opportunity to buy debt. But what kind of investments are they?
UK government bonds are commonly referred to as 'gilts', a word that stands for 'gilt-edged security'. They are issued by Her Majesty's Treasury and are listed on the London Stock Exchange. You can easily find this and other information, including a full list of current issues, on the UK Debt Management Office website.
There are at least two kinds of gilts: 'conventional' gilts and 'inflation-linked' gilts. The former is a government bond that pays a fixed rate of interest, while the latter is a government bond that pays a variable rate of interest, in the sense that it is adjusted for changes in inflation. The other major subdivision is by maturity. In this case, gilts cover both the short and the medium to long term. Interestingly, within gilts there is also the perpetual bond, which is a debt security that has no maturity date but pays out to investors on a regular basis (as it may never be repaid, the reference price is mainly the market price, which implies a higher average risk and volatility).
What drives many investors to include a certain proportion of government bonds in their portfolios, and many savers to subscribe to them, is their nature as relatively safe investments that are able to distribute returns on a regular basis. As Wikipedia notes, most gilts are also subscribed to by pension funds and insurance companies. In the case of these institutional investors, the function of government bonds contributes to the overall strategy of the investment portfolio: it guarantees stable and relatively safe returns, but also serves to provide some diversification.
One of the main risks for those investing in government bonds is interest rate risk. The mechanism is well known: when the Bank of England decides to raise interest rates (as it has done over the past year and a half), the value of gilts already in circulation tends to fall. The reason is simple: new issues tend to offer higher yields. One risk (relative to yield targets) is that coupons will not be sufficient to overcome the erosion of the value of money caused by inflation. A specific risk, on the other hand, relates to inflation-linked gilts: in this case, the risk is that inflation will be lower than expected, with the consequence that the coupon yield will be lower than expected.
But be careful: when we talk about changes in the price of gilts, we are talking about the market value, i.e. the value resulting from buying and selling on the secondary market. In fact, the gilt has a nominal value that lasts from the moment it is issued until it matures. In other words, it is the purchase price at the time of issue and the redemption price at the time of maturity. However, when they are traded on secondary markets, the value of the security is subject to fluctuations based on the dynamics of supply and demand, and can lead to capital gains on the one hand and capital losses on the other.
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