Short Dated Bond Strategy

The Bank of England surprised markets in September with the lack of a widely anticipated further interest rate rise, marking the end (or at the very least, pausing) one of the greatest tightening cycles for generations.

Inflation has proved to be stubborn since late 2021 (the latest annual inflation figure coming in at 6.7% for August 2023) and consequently, this has resulted in 14 consecutive rate hikes in the last 20 or so months. 

Whilst this has been a very difficult couple of years for those with mortgages, investors, and businesses alike, it has been great news for savers who have seen the interest rates on their accounts rocket from a little over 1% p.a. to in excess of 6% p.a. – something not seen since prior to the Global Financial Crisis in 2008.

It has also meant that significantly higher yield has returned to the bond markets for the first time in over a decade. Higher interest rates have resulted in both UK government and corporate bonds being issued at much higher rates of interest than at any point in the last 15 years.

If you are a higher or additional rate taxpayer, with that comes an opportunity.

What is the opportunity?

Interest rates have been so low over the last 15 years, the UK government was able to borrow from the markets at very low rates of interest. At times during this period, some Gilts were issued with a coupon as low as 0.10% p.a.

With interest rates rising significantly over the last couple of years, the interest offered by these older, low coupon Gilts are now far less attractive than newer Gilts that have been issued in this higher interest rate climate. Consequently, the value of the older Gilts in the market have fallen below their original nominal value of £100 and are trading at significant discounts to their maturity value.

Given that Gilts will redeem at their nominal value if held to maturity, there is an opportunity to buy these older, low coupon Gilts significantly below their maturity value, whereby the majority of the return is generated by way of a capital gain.

• For example, if a Gilt maturing on 31^t January 2025 is currently trading at £93.00, if you bought it now and held it until it’s maturity date, you would be repaid its nominal value of £100, thereby making a capital gain of 7%.

This is particularly attractive for higher and additional rate taxpayers, as while the interest paid by Gilts is taxable at the individual’s marginal rate of income tax, capital gains made on UK Gilts are tax-free.

In summary, this means that a higher or additional rate taxpayer could generate a significantly better net of tax investment return from holding a low coupon Gilt, than holding the same amount in a bank deposit.

In the table below, we have provided an illustrative return comparison that could be enjoyed by higher and additional rate taxpayers by holding a short-dated Gilt, alongside the equivalent rate that would need be offered by a bank deposit to achieve the same net of tax return:

*This shows the equivalent interest rate that would need to be offered by a bank deposit to generate the same level of interest as the above short-term Gilt.

What are the risks?

It is important for investors to be aware that there will likely be price fluctuations between now and when the bond matures. Therefore, if you needed to sell the Gilt for whatever reason prior to its maturity date, then you may receive back less than you originally invested. If, however, you are able to commit to holding the Gilt until its maturity, then this is a very attractive way of generating a higher net of tax return than holding your surplus savings in a bank deposit.

Are there any minimum investment amounts?

Generally, we would suggest minimum investment amounts to be greater than £250,000. However, this would be considered on a case-by-case basis.

How do I find out more information?

Authors

Approver Quilter Financial Services Limited & Quilter Mortgage Planning Limited 27/09/2023

Past performance should not be regarded as a guide to future performance.

Exit Strategy planning are not regulated by the Financial Conduct Authority.

Tax treatment varies according to individual circumstances and is subject to change.

The value of investments can fall as well as rise. You might get back less than you invested. You should only consider these products if you are willing to take some risk with your capital. We will consider whether such products are suitable for you before recommending an investment.

Quilter Cheviot Financial Planning is a trading name of Quilter Private Client Advisers Limited which is an appointed representative of Quilter Financial Services Limited and Quilter Mortgage Planning Limited, which are authorised and regulated by the Financial Conduct Authority.

Registered in England and Wales. Registered number: 06201261, registered address: Senator House, 85 Queen Victoria Street, London, EC4V 4AB.

Quilter Financial Services Limited and Quilter Mortgage Planning Limited is entered on the FCA register (https://register.fca.org.uk/s/) under reference 440703 and 440718. Trusts, Estate planning, some Buy to Let Mortgage, Taxation and Inheritance Tax Advice are not regulated by the Financial Conduct Authority.

The representative member of the VAT group is Quilter Business Services Limited. VAT registration number: 386 1301 59.