I have written a few times in recent years urging Monevator readers not to give up on gilts. (That is, UK government bonds.)
That wasn’t because I’m a diehard gilt groupie. On the contrary, for most of my investing life my allocation to bonds has hovered closer to the flatline than investing orthodoxy would think wise.
However even as rootin’, tootin’, stock-lovin’ active investor I could see that many passive investors were throwing the bond baby out with the bond bear market bathwater.
Who could blame them after the post-Covid, post-Liz Truss bond rout?
As interest rates rose with inflation coming back from the dead, grossly-overpriced bonds crashed. The result was one of the worst stints for UK investors in government bonds of all-time.
Here’s how the iShares core UK 10-year government bond fund swan-dived into the Liz Truss lows of 2022:
Source: Fiscal AI
You don’t need to be Warren Buffett to guess what seeing ‘safe’ assets plunge like this did for investor appetite.
“Be greedy when others are writhing on the floor, breathless, and calling for mummy”, anyone?
No thanks, said many shell-shocked would-be bond buyers.
Once more unto the breach
However, if investors did make a mistake in trusting the market’s wisdom before the bond crash, it was by buying bonds on negative yields that could only deliver a negative return in the long run.
Yet following the bond rout that troughed in 2022, yields-to-maturity were positive across the curve.
At least in nominal terms, gilts were now priced to actually reward investors for holding them.
So it seemed to me some investors were closing the door on gilts after the horse had bolted, run into a ditch, and been winched out looking beaten-up, sure, but ready to run again.
Note: I wasn’t suggesting UK government bonds were a surefire winner. Nor that they’d give Bitcoin or the Magnificent Seven mega caps a run for their money.
It was just that with yields restored to something closer to normal, I felt they could be added to portfolios once more without all that existential negative yield drama.
Gilt trips
So how have gilts performed since those dark days of 2022, when Britain pondered whether a lettuce would do a better job of steering the ship of state?
Well, if you’d muttered “jog on Investor” on reading my articles and kept on shunning gilts, you’d be happy enough. That’s even if you’d parked your money in cash or money-market funds – let alone bought more equities instead.
Because gilts have meandered around doing nothing much since. Indeed with hostilities in Iran, the resultant inflation scare saw the 10-year gilt yield break briefly above 5%, before it fell back on news of a tentative ceasefire:
Source: CNBC
Remember, yields move inversely to price with bonds. All things equal, higher yields on gilts reflects lower prices for existing gilts in the market.
Cor Blighty
As an aside, it’s worth noting that Britain is still considered something of a basket case by international investors.
As CNBC reported towards the end of March:
One of the most alarming aspects of the sell-off in risk assets after the attacks on Iran, from a British perspective, has been how gilts – U.K. government IOUs – fell more sharply than bonds issued by any other G7 economy.
Take the 10-year gilt, the most liquid and most widely-traded of all gilt maturities and the best proxy for the U.K. government’s long-term borrowing costs.
At one point […] the yield hit 5.115% – a level not seen since the global financial crisis in April 2008.
These moves were much sharper than for other G7 countries. Indeed among similar economies only Australia has a higher 10-year yield.
The CNBC author covered the reasons why:
One is that the Bank of England’s policy rate was already the highest of any G7 central bank and Britain’s rate of inflation is higher than that of its peers.
A second is that interest rate expectations for the U.K. have changed more dramatically than any other G7 economy. Before the conflict, the Bank was expected to cut its main policy rate this month – sparking a sharper reaction in gilts.
A third is that, Japan aside, no G7 economy depends more on imported gas – the price of which has surged.
Fourthly, investors dislike U.K. politics. The surge in energy prices has raised fears of higher spending – funded by growth-destroying tax increases or more borrowing – to support households. They also fear that May’s local elections, should the governing Labour Party perform poorly, will result in a leadership challenge to Prime Minister Keir Starmer and his possible replacement by a more left-wing rival.
But demanding a premium to hold gilts is not new. It was reinforced to the British public most starkly in recent times when, in September 2022, gilts sold off violently after Liz Truss’ government unveiled a mini-Budget including £45 billion worth of unfunded tax cuts.
Market participants spoke of investors demanding a ‘moron premium’ to hold gilts over bonds of equivalent duration issued by peers.
As I’ve pointed out many times in our debates about Brexit, Britain is a relatively small nation that relies on trade for its economic health and ‘the kindness of strangers’ to shore up its finances. It’s been prone to higher inflation than the continent for generations. In leaving the trading bloc we’ve increased those vulnerabilities.
Add in an energy shock and an anti-climactic regime change in Downing Street and there’s still very little for global bond investors to get excited about.
Greater expectations from gilts
So far, so soggy then for gilts.
However there’s still that silver lining to higher bond yields. Namely higher expected returns.
As we pointed out back in 2022:
Rising bond yields are positive for long-term investors who can ride out the capital losses and eventually take advantage of fatter income payments.
Much of the doom and gloom after the Financial Crisis concerned the fact that low yields meant miserly long-term bond returns. It dragged down the equity risk premium as well.
Now, rising rates and a return to the old normal is leaving that particular threat in the rear-view mirror.
Higher coupons should lower bond volatility. They plump up your safety cushion against equity losses, too.
For sure as our article pointed there was a risk that yields would continue to rise.
Inflation will always be a threat to conventional bonds, too.
But the main point was that investors reeling from nominal losses of 30% or more in their gilt allocations were very unlikely to suffer that again from the 2022 starting point. An unusually extreme situation had unwound.
And sure enough, we haven’t seen a repeat of that carnage. While gilt returns have been the definition of ‘meh’ since then, they’ve not blown up any portfolios.
Rather, here’s how owning that iShares 10-year gilt fund (ticker: IGLT) and reinvesting the coupon has performed since the end of 2022:
Source: Fiscal AI
Okay, nobody is posting rocket ship emojis on the back of a 3.4% total return. But it is positive.
What about long duration index-linked bonds? How have they done since I pondered a potential opportunity in index-linked gilts in summer 2023?
Well here’s the total return of IGLT’s index-linked sister fund from iShares (ticker: INXG):
Source: Fiscal AI
That return is negative, which is disappointing – but it’s not negative by much.
Also the opportunity my article was flagging (early) was the emerging chance to buy a positive-returning index-linked ladder at last.
Still, I can’t deny I thought INXG might bounce back a bit more quickly than this.
Short thrift
On the other hand – and especially in his articles since 2022 – The Accumulator has repeatedly suggested that nervous would-be gilt investors should shorten their bond allocation’s duration.
That is, that they should plump for shorter-term bonds (or bond funds) that are less susceptible to interest rate risk.
So here’s how Amundi’s 0-5 year gilt fund (ticker: GIL5) has done since the 2022 annus horribilis:
Source: Fiscal AI
That’s more like what most people want from their bonds!
If we could guarantee even modest ‘up and to the right’ returns from gilts then we’d all be up for owning them. (Spoiler alert: we can’t guarantee that.)
Long odds
At the other end of the spectrum, those ultra long-term gilts like the cultish Treasury 2061 (ticker: TG61) we looked at last summer did rally, but they’ve more recently spluttered out with the war and inflation fears.
For the record, as I type you can lock-in a yield-to-redemption of 5.3% on TG61.
My friend who I quoted in that 2025 article owns his allocation of ultra-long gilts for tail-risk depression insurance. And where else can you get insurance that pays you a decent income while you wait?
It’s sure to have its moment in the sun some day… isn’t it?
Gilts: complex
What you think this wander through the recent returns from gilts proves perhaps depends on what you thought back in 2022. There’s a bit of something for everyone.
I’d hope though that if you honestly expected the intense bond pain to continue, then you at least now take the point about a one-off reset from negative yields, and also how higher yields are good for future returns.
More generally, let’s filch a graphic from The Accumulator. Here’s a quick reminder for why most investors would want to own some government bonds:
You’ll notice ‘stonking gainz’ is absent from TA’s summary.
Most investors aged over 30 or so are advised to own some bonds (or similar lower-risk stuff such as cash) because going all-in on the likely best-performing asset – equities – may be too risky and volatile.
And now gilt yields are normal again, their role as a potential portfolio stabiliser has been restored, too.
Indeed, turn your eyes from the stock market bull run and gilts arguably look quite attractive. The likes of Vanguard expect 10-year gilt returns of around 5-6% a year over the next decade.
This isn’t a bold prediction. The starting yield (to redemption) of gilts is a great guide to your expected returns. Remember, 10-year gilts are already yielding close to 5%.
Goldilocks gilts
Of course we all learned some lessons from 2022.
I’d still contend that Monevator was relatively cautious about gilt returns for a passive-focussed site in the near-zero years before the crash, as a search of our archives will attest. (This prescient warning by The Accumulator from 2016 about negative-yielding index-linked gilts is a case in point).
However it’s fair to say we took our lumps, too.
Our house view now is that prudent diversification should also consider holdings of cash, gold, and potentially commodities. As well as even more careful thinking about bond duration, and perhaps making use of gilt ladders if pure inflation hedging and/or a sequence of real cashflow returns is all-important to you (such as if you’re in retirement and drawing an income).
It’s also true that if governments eventually try to inflate away their ballooning national debts, then the returns from conventional gilts could yet be very poor in real terms.
On the other hand, perhaps they won’t or can’t. And there’s always index-linked gilts to own, too.
Remember all investment choices involve trade-offs. Nothing is 100% ‘safe’ and risk cannot be created or destroyed – only swapped for other kinds of risk.
In particular, if you believe there’s no downside to holding cash or MMFs instead of, say, intermediate-duration gilts, then The Accumulator has shown that historically it would have cost you via lower returns.
Finally, it’s been ages since we had a prolonged bear market for shares. The notion that you had to make the case for an allocation to fixed income will look very strange in such times, if history is any guide.
