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Should you buy gilts directly or invest in a gilt fund?

Deciding between directly buying gilts or investing via a fund.

A common question among DIY investors is whether they should buy gilts directly or invest in a gilt fund.

The answer depends on why you’re buying gilts1, and on how confident you are at managing your own holdings.

Let’s step back and consider the three main reasons for owning gilts:

Diversification – Most portfolios include an allocation of government bonds, since they are more secure and less volatile than equities, and their price tends to move in the opposite direction, diversifying portfolios.

Income – Gilts pay a fixed income in twice-yearly installments, with the running yield determined by the price you first paid for them.

Security – You’ll get the par value of a gilt (invariably £100) back when the gilt matures in 5, 10, or however many years time, as specified by the gilt’s name. The UK government has honored its debts for centuries, and so gilts are generally considered a risk-free investment.

Remember: The par value of your gilts may be less than you paid for them, and you may get less than par if you sell up before they mature. See my corporate bond series for more on why bond prices fluctuate.

Whether you choose to buy gilts direct or invest via a gilt fund, you’ll be exposed to these the main factors above – but to varying degrees. Depending on what you’re holding gilts for, different factors will be more important to you.

Buying gilts directly

Gilts can be bought, held, and sold just like shares, although far fewer private investors ever do so.

Most online brokers enable you to buy and sell gilts for their normal trading fee, and the bid/offer spread is usually reasonable. (Most investors will want to hold their gilts to maturity, anyway, so won’t need to worry about selling).

Alternatively you can buy gilts from the government’s Debt Management Office. You’ll still be charged a fee, and you have to trade by post and pay by cheque, and take whatever price is prevailing for your gilts on the day, all of which is a faff. The dealing fees can be cheaper in some cases, though.

To determine which gilts you want to buy, you can use various online resources to find out bond prices and yields.

There’s no real difference between the different fixed term, fixed rate gilts except their price, their coupon (and hence their running yield), and the time until maturity.

Okay, that is actually a fair few differences, but the point is it’s not like share investing where you have to research the underlying company. All gilts are backed by the same issuer – the United Kingdom!

Advantages of buying gilts directly

  • You don’t pay annual management fees to a fund manager. After your initial trading costs, there’s no more fees to pay (assuming you hold the gilt to maturity).
  • You know exactly what income you’ll get every year from your gilts.
  • You can ignore capital fluctuations, knowing you’ll get back the par value of the gilt if you hold it to maturity.
  • You can construct your own ‘ladder’ of gilts2, to smooth out the impact of varying rates in the market.

Disadvantage of buying gilts directly

  • Your gilts will rise and fall in value every day – perhaps markedly in the case of long-dated gilts.
  • You’ll need a reasonable sum if you want to create a nice spread of gilts.3.
  • As your gilts mature you’ll need to spend time researching and buying new holdings.
  • You may be tempted to try to trade your gilts for capital gains, which is not advisable if you’re holding them for another purpose such as diversification.
  • Only gilts with five or more years left to run when you buy can be held in an ISA.

Investing in a gilt fund

The first choice with a gilt fund is whether to go with a passive gilt fund or an actively managed one.

Buying a gilt ETF is a very easy way to diversify your portfolio. The iShares IGLT exchange traded fund, which holds a wide basket of gilts, is a good option.

Alternatively, there are plenty of managed gilt funds about, although you need to read the descriptions carefully to see exactly what they invest in. Many bond funds use words like ‘strategic’ and ‘alpha’ to muddy the waters; it’s too easy to discover what you thought was a UK gilt fund buying Indonesian government bonds, so be sure to read the small print.

As ever, the ETF option beats the managed funds on the all-important cost criteria. After trading fees to buy the ETF, the annual charge is just 0.2% a year.

Managed gilt funds in contrast charge big upfront fees (which can be sidestepped by using a fund supermarket) and up to 1% a year in total expenses, which is a huge amount out of your return when yields are low.

Active gilt funds also differ in performance due to their managers’ attempts to trade gilts for a profit, with some beating the market and some lagging. As usual, there’s no sure way to know which funds will do well in advance.

Advantages of investing in a gilt fund

  • It’s a one-shot asset allocation decision.
  • You don’t have to learn about gilts, but can instead leave it to the professionals.
  • Your fund will invest across a range of maturities, and this diversification should provide a reasonable buffer against big valuation moves.
  • An active gilt fund manager may also use derivatives and the like to further reduce volatility in the fund.
  • You can hold your gilt fund in an ISA.

Disadvantages of investing in a gilt fund

  • The diversification of your fund will not stop its value rising and falling entirely, and since it’s open-ended there’s no guarantee whether or when you’ll get back what you put in. (Compare that with a fixed term gilt that redeems at par).
  • Annual costs. Even the 0.2% TER of the iShares ETF isn’t negligible in an era when yields are in the 3.5% range. As for 1% a year, ouch!
  • If you choose an active fund, its return may lag the gilt market if the manager is drunk misjudges things. You might want to invest in a couple of different funds to spread this risk.
  • There’s (a very small) additional risk of fraud or similar if you invest via a fund manager, versus holding the gilts yourself.
  • Gilt funds are liable to capital gains tax (if held outside of an ISA).

So which is right for you?

I think most people who read Monevator are capable of buying and holding gilts directly, whether they buy via their online broker or the DMO.

And in most cases, I think buying gilts directly is the preferable route, too. It’s usually cheaper, and you can lock in the interest rate you’ll be paid for each issue, which is one big advantage of owning gilts in the first place.

You also know when you’ll get your money back – and how much you’ll get. This is handy if you know you’ll need a particular amount of money for some specific future use, such as paying Jemima’s university fees.

But pure passive investors shouldn’t sweat about taking the gilt ETF route. Funds are also the best choice if you’re too lazy or busy to dedicate time to your gilt portfolio.

The good news is that whether you buy gilts directly or invest in a gilt fund, you’ll get roughly the same diversification benefits. So the decision as to how to invest really comes down to which advantages outweigh the disadvantages for you.

  1. The common name for UK government bonds []
  2. This is an article in its own right, but in essence you buy gilts with different maturities – say five issues with 2,4,6,8, and 10 years to run – and over the years recycle the money from gilts that mature into buying new gilts at the long end of your ladder []
  3. At least £10,000 I’d suggest, to be invested in five tranches of different gilt issues. £14,000 across seven issues would be a better minimum []
{ 7 comments… add one }
  • 1 Niklas Smith December 16, 2010, 4:52 pm

    “After trading fees to buy the ETF, the annual charge is just 0.2% a year.”

    In this case there is a fund that is better: Legal and General’s gilt index funds (one for ordinary gilts, one for index-linked) both charge 0.2% per year (TER is also 0.2% IIRC) and don’t involve trading fees.

  • 2 The Investor December 16, 2010, 7:32 pm

    @Niklas – Hmm, it sounds well worth consideration but I’m struggling to find it on L&G’s fund homepage? Does it live somewhere else? Thanks in advance!

  • 3 The Accumulator December 16, 2010, 11:20 pm

    The L&G All Stocks Gilt Index Trust isn’t advertised on their retail homepage. They claim it’s for institutional investors only, but small fry like us can get it through a number of brokers/supermarkets.

    TER = 0.25% AMC = 0.2%

    Vanguard’s U.K. Government Bond Index Fund is cheaper than any of ’em, TER 0.15%, initial charge 0.1%.

  • 4 The Investor December 16, 2010, 11:32 pm

    @Accumlator – Thanks for that. How annoying the L&G fund isn’t one of their normal retail offerings! I really like the way you can switch between their funds for free as a holder, and I’m not overly bothered by the 0.1% difference in TER given the chopping and changing I do elsewhere.

    One thing that is up for further research – and is more a post for you than me I expect Accumulator 🙂 – is what exactly the index is these various bond funds track, and indeed whether they track different ones…

  • 5 Marc December 18, 2010, 8:28 pm

    @TA This was something I was briefly confused about as it isn’t particularly well documented.

    So for anyone who doesn’t already know; on sites such as TDW and iii.co.uk funds marked RET are for retail customers (not to be confused with retail sector investments!), and INST for institutional investors.

    [… and darn both of them for not offering Vanguard funds still]

  • 6 Steve January 20, 2015, 10:35 pm

    As I understand it, income from holding gilts directly is treated as income for tax purposes, not dividends. This seems fairly logical and clear. (So correct me if I’m wrong!)

    What happens if you hold a gilt fund/ETF outside an ISA/SIPP? I assume the income from the gilts held by the fund is paid out to investors as dividends on the fund, but do these dividends get taxed as income or as dividends? I’ve tried to Google this and haven’t come up with anything…

  • 7 KayBea July 27, 2019, 6:55 pm

    sorry but i am a bit of a beginner to this investing lark…. if I buy guilts via the DMO how do I put them in my SIPP wrapper….

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