Hedge fund managers are taking an upbeat view on UK government bonds as concerns mount over artificial intelligence expenditure by US tech giants.
Investors have traditionally viewed gilts with boredom or fear over state spending, with national debt standing at £3trillion, equivalent to 95 per cent of national output. However, hedge fund professionals argue that bad news is already priced into gilts and that the bonds offer an alternative to volatile tech shares.
Hedge funds seeking profits across market conditions favour the guaranteed money-back pledge when gilts reach maturity. This repayment commitment has been kept continuously since gilts were first introduced in the 17th century, while current gilt yields provide returns above inflation.
Political impact on UK gilt yields
Gilt yields rise when bond prices come under pressure from higher inflation, interest rates, political uncertainty, or the appeal of equities. Before entering No 10, Andy Burnham said Britain should "get beyond this thing of being in hock to the bond markets."
Burnham's statement caused five-year gilt yields to spike above 5 per cent and 10-year yields to reach 5.04 per cent. The upcoming Budget on October 28 could trigger another yield surge if Chancellor John Healey presents major spending proposals in his first Budget.
Ben Yearsley of Fairview Investing said: "I think gilts are a great idea for a portion of your wealth right now, whatever you may think about Burnham’s plans." He noted that five-year gilts yielding 4.5 per cent and ten-year gilts yielding over 5 per cent provide real returns after inflation alongside tax breaks.
Richard Carter, head of fixed interest research at wealth manager Quilter Cheviot, urged caution regarding hedge fund statements. Carter said: "Hedge funds are selling AI stocks to de-risk their holdings, but they are also famously opaque and secretive about their strategies, suggesting they may not see gilts as a long-term opportunity."
Carter added: "For retail investors, however, short-term gilts with upcoming maturities continue to look attractive, given the yields and the tax-free income."
Global economic factors and market risks
A broader shift in market sentiment could cause gilt yields to fall slightly later this year. Global market attention has focused on interest rate policies in Japan and the United States, while UK interest rate increases now appear less likely.
The UK jobs market remains weak, and inflation has not risen as high as feared despite oil price spikes from Middle East conflict. Meanwhile, anxieties over tech giants spending billions on AI are compounded by concerns that a slowdown in tech investment could drag down global economic growth.
Aaron Hussein, global market strategist at JP Morgan Asset Management, suggested that "government bonds are the best hedge or protection against such an eventuality." Although the US S&P 500 index has risen 13 per cent this year and the FTSE 100 is 8 per cent higher, Hussein warned that "the ground beneath them tends to be less solid than it appears."
Gilt maturity structures and tax benefits
UK Treasury gilts are divided into short-dated (zero to seven years), medium-dated (seven to 15 years), and long-dated (15 to 50 years) maturities. Gilts pay a taxable fixed rate of interest, known as a coupon, and offer full repayment at a par value of £100 per unit at maturity, with no record of government default.
Investors can also buy UK Treasury Bills, known as UK T-Bills, which pay no coupon interest and deliver their full return at maturity. Broker Interactive Investor highlighted an example of a six-month T-Bill issued at £97.50, yielding a 2.65 per cent gain up to £100, which equates to an annualised yield of 5.12 per cent.
Potential tax increases in the Budget add to the appeal of gilt tax breaks. While coupon interest is taxable unless held within an Individual Savings Account (Isa), any capital gain realized by holding a gilt until maturity is exempt from capital gains tax.
Sarah Coles of investment platform AJ Bell highlighted low-coupon gilts issued during pandemic zero-interest rate periods, such as the Treasury 01.25pc January 31 2028 gilt issued in June 2020. Currently priced at £94.48 with a running yield of 0.12 per cent, it repays £100 at maturity, delivering a tax-free yield to maturity of 4.05 per cent.
By comparison, NatWest digital provider First Active offers savings accounts at 4.5 per cent interest. After savings tax, that returns 3.6 per cent for basic rate taxpayers, 2.7 per cent for higher rate taxpayers, and 2.5 per cent for additional rate taxpayers, with savings tax rates set to rise 2 per cent next April.
Buying options and investment strategies
Investors can purchase gilts through the Treasury agency Debt Management Office (DMO) or via platforms such as AJ Bell, Bestinvest, Hargreaves Lansdown, and Interactive Investor, which list approximately 90 available gilt issues.
Caution is advised for ultra-long maturities like the Treasury 5.375 per cent 31/10/2056 Gilt yielding 5.7 per cent. Exchange traded funds such as iShares Core UK Gilts, Vanguard UK Gilt, iShares UK Gilts 0-5 Year, and Invesco UK GILT 15+ Year offer simple exposure across different maturities, though fund holdings do not receive capital gains tax exemptions.
Many investors, particularly retirees, build a gilt ladder by acquiring low-coupon or zero-coupon gilts trading below £100 with maturity dates aligned with future financial needs, such as mortgage payments or holidays. While laddering requires administrative effort and misses share market growth, roughly 90 per cent of regular returns can be tax-free alongside guaranteed principal repayments.
