Benstead on Bonds: why gilt auction access is a win for small investors

A key barrier to fixed income investing for DIY investors has been broken down.

Last month interactive investor customers were invited to take part in the auction of a UK government bond, known as a gilt. Crucially, DIY investors were given commission-free access to the new issue at the same yield as large investors for the very first time. They will be invited to participate in future auctions as well.

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Working with market maker Winterflood, customers could buy at launch the 4% Treasury Gilt 2031 (T31), which is a UK government bond expected to yield around 4% and due to mature in seven and a half years’ time. 

Investors purchased the gilt at the “non-competitive auction price”, which is the average accepted price for the gilt. The gilt dealt at 99.44p, meaning a yield of just over 4% for investors holding the bond to maturity in seven years’ time. It pays the £4 coupon over two annual payments, on 22 April and 22 October, with the final coupon and par value due on 22 October 2031.

Applications were met in full, meaning customers received 100% of the amount they applied for rounded down to the nearest whole unit. The minimum investment was £1,000 with multiples of £100 allowed after that.

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Coupon payments from gilts are taxable as income if held outside an ISA or a SIPP, but capital gains are not taxed on gilts. Gilts bought at auction can be held inside a tax-efficient SIPP or ISA, as well as a trading account.

While gilts are relatively easy to trade on the secondary market, accessing them at issue has until now been the preserve of professional investors as the minimum denomination was £500,000.

Inviting retail investors to participate on the same terms as large investors is therefore a huge breakthrough for democratising investment, something which is part of our mission at ii.

Andrew Stancliffe, head of execution at Winterflood, told me that they had been working on this investment solution for months and he is delighted that it is now a reality.

On our side, head of investment solutions John Dobson called it “an exciting development” for retail investors.

He says: “By providing early access, investors get in at the average price and do not have to worry about secondary market movements and the spread on buying and selling. interactive investor also provides this commission-free.

“Ultimately, interactive investor is all about giving its customers choice. Gilt trading has seen extraordinary growth with the current interest rate environment, and we hope this encourages a broader range of investors to consider them as a part of a well-diversified investment portfolio.”

Why buy gilts at auction?

So, what are the advantages of participating in gilt auctions rather than buying gilts already in issue?

First, it is cheaper. There is no commission to ii to participate in the auction, and no bid/offer spread to pay or trading fee (£3.99 if dealing online at ii), unlike when trading gilts already in issue.

Another key advantage is that investors have more clarity on the yield they will receive, which is set following the auction. When buying gilts trading in the secondary market, the yield is a result of the market price of the gilt, but finding accurate yield to maturity figures is currently tricky for existing bonds without a paid financial data subscription.

In addition, yields are likely to be higher than the income offered by National Savings & Investments (NS&I) accounts, which is the other way that savers can get an income from the UK government without trading gilts on the secondary market.

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For example, the NS&I 3-year fixed rate Green Savings Bond yields 2.95%, but a 3-year gilt currently yields 4.2%. NS&I Income Bonds, which pay out monthly, currently yield 3.65% on an annual basis, while its Direct Saver pays 3.65%, with interest paid annually. However, these rates are subject to change, and investors are not locking in a yield.

Investors can choose to hold the gilt bought at auction to maturity, and therefore do not have to worry about price fluctuations, or selling the bond on the secondary market.

A final point on why I’m excited about the prospect of gilt auctions is that it begins to break down the exclusive world of bonds and gives regular investors access to an extremely important asset class.

What may start with gilts, could progress to corporate bonds, meaning that investors can lock in yields from fixed income that beat returns available on cash savings accounts. While it is early days still, direct access to fixed income looks set to keep improving, giving investors more choice with what they do with their money.

What are the disadvantages?

Some gilt auctions can be for longer duration bonds – and not everyone wants to hold a bond for its life, especially if it is more than five or six years. While seven years is in the shorter range for large investors looking to match liabilities using bonds, seven years could be a significant amount of time for a DIY investor. Selling early leaves you vulnerable to changes in the value of the bond.

There is also slight uncertainty over what the yield will be as it is set at auction, with the price of a gilt set higher or lower than the £100 par value depending on demand from large investors.

Tax is another thing to consider. One of the biggest benefits of buying gilts is that capital gains are tax free – this can be when selling a gilt at a profit before it matures, or receiving an uplift by buying a bond below its £100 par value and then receiving the £100 back when it matures.

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Because lots of gilts were issued with very low coupons before 2021 due to interest rates being so low, their prices fell so that the yields (a function of coupon and the price of the bond), came into line with market rates.

This means that bonds such as UNITED KINGDOM 0.25 31/01/2025 (LSE:TN25) and UNITED KINGDOM 1.5 22/07/2026 (LSE:TG26) (yielding to maturity 4.7% and 4.1%, according to Tradeweb) cost £96 and £94 to buy. They mature in January 2025 and July 2026. A large part of the gain will be capital uplift when the bonds mature, which would be capital gains tax free even if held outside an ISA and a SIPP.

A final thought to bear in mind is that buying a bond at auction means that the coupon is what gives you your yield, not any uplift to par value on maturity. This could make it less tax efficient for some investors who are buying gilts as a tax planning tool.