Playing It Safe With Gilts Could Be A Gamble

Government-backed gilt-edged bonds may not be the safe investment they once were according to one of Yorkshire’s top IFAs.

Gilts, which pay a fixed rate of income and promise repayment of the capital on a fixed date in the future, have long been viewed as a safe haven for investors in times of market volatility. As such, they have become a core part of many people’s savings and pension portfolio.

As with most investments, the price of a gilt depends on supply and demand. A combination of factors in recent years has generally pushed gilt prices higher. Quantitative Easing and political uncertainty have precipitated a so-called ”˜flight to safety”.

However, when demand has been high for gilts, the yield that they offer becomes less attractive, delivering poor overall returns. (The yield is the interest paid expressed as a percentage of the gilt purchase price).

Conversely, the prospect of inflation and interest rate rises has seen the market for gilts change rapidly in the past few weeks.  Demand fell in June and many long-term gilts experienced sharp price falls.

This is cause for concern says Stephen Baxter, Joint Managing Director of Robertson Baxter, who believes a market correction in gilts triggered by rising interest rates could bring significant losses for some investors.

“Mark Carney and the Bank of England suggested that interest rates may have to rise and this resulted in a recent sell-off in bond markets.

“As a result, if you own gilts you may suffer considerable losses on your holdings. A 1% rise in gilt yields would lead to a fall in the capital value of a 10 year gilt of up to 10% and a 30 year gilt of up to 24%. So, whilst gilts have previously been classed as low risk assets that might not be the case,” said Stephen, whose firm manages the financial future of very high net worth individuals, trustees and charities across the region.

“You may not realise that you hold gilts sold as ”˜cautious’ or ”˜multi asset’ funds. If you are a member of a pension scheme you may be invested in the default option. These often take a ”˜lifestyle’ approach shifting assets in areas considered less risky.

“Conversely higher gilt yields may mean higher annuity rates, which could potentially be good news for those nearing retirement.”

Mitigating losses can be achieved in many ways but the safest way according to Stephen is through a fully diversified investment portfolio.

“This will have a mixture of asset classes including alternative investments,” added Stephen. “These alternative investments, such as property and infrastructure funds are proving popular, as are other funds linked to debt such as Corporate Bond funds.

“Always seek the advice of a professional financial planner to determine the level of risk that you are prepared to take. Aim to construct a fully diversified portfolio designed to weather the volatility in particular asset classes by providing a balanced return across the investments.”