The Art of Green Finance

Gilts are short to medium term bonds issued by the UK government. Essentially, the government is asking to borrow your money and is prepared to pay interest in return. As such, they are an incredibly safe investment, as it is highly unlikely that the UK government will default on these loans – economic chaos would insue. Gilts pay interest on a regular basis (usually twice per year) and the annual amount paid is equal to the coupon rate. At the end of the term, the capital you have invested is returned. The downside is that the coupon rate has been very low in recent years. However, in 2023, gilts with coupon rates up to 6% were released.

The vast majority of gilts that are issued are purchased by pension funds, investment funds and traders, as they are considered a useful holding in a diversified portfolio. Gilts are common traded.

Gilts can be purchased directly from the government’s Debt Management Office once you have been accepted as an approved investor. The alternative way to buy gilts is via a trading platform such as Hargreaves Lansdown.

When buying gilts, there are 3 factors to consider; the headline coupon rate, the time until maturity and the cost of the gilt.

For example, gilts are listed as Treasury (UK gilts), 4% (the coupon rate), 5/2/2027 (date of maturity). The price is also listed on trading platforms e.g. 95p.

Because gilts are traded, gilts with a low interest rate or long time period until maturity may be sold for much less than the face value of rate of 100p aka the par value. This means that if you buy these “discounted” gilts and hold the gilt to maturity, you will get back more than you paid for the gilts. In other words, you will have made a capital gain in addition to recieving regular interest pay outs.

Therefore, in order to see how much your overall investment will make, you need to do some maths!

If you are most interested in the regular interest payments, you can calculate the running yield:

Coupon rate / price x 100 = running yield e.g. 4/95 x 100= 4.21%.

The yield including capital gains (or capital losses!) can also be calculated. As this is a more complex calculation, use an online calculator such as this one.

In 2024, it was possible to get a running yield of approximately 4.5% over a 15-18 year time frame without significant capital loss. Importantly, this was higher than the inflation rate at the time. For those close to retirement and looking for a regular income, or for those looking for a safe investment and not willing to take a bigger risk by investing in stocks and shares, gilts could be very attractive. Gilts can also be sold, so if you need access to the cash, they are a relatively liquid asset. However, if you sell the gilts at the market value, you may get back less than you paid.

Holding Gilts.

Interest from gilts is subject to tax, unless there are held within a tax-free wrapper such as an ISA or pension (SIPP). Only gilts that run for 5 years or more can be held in an ISA. Capital gains on gilts are tax-free. Therefore, there may be some tax incentives to buying gilts for capital gains, rather than income, particularly for those who have used up their annual ISA allowance.

How Ethical are UK Gilts.

Essentially, you are lending money to the UK government, so you need to consider how the UK government spends its money. Almost half of government spending is on health, education, social welfare and pensions. There is also significant spending on public order and safety, transport and overseas aid. One category that may be ethically questionable though, depending on your political stance, is defence spending which accounts for slightly less than 5% of government spending. Half of the defence budget is spent on wages. However, almost 40% of the defence budget is spent on equipment, equipment maintanence and research and development, which is likely to include money being spent with private firms such as BAE systems, a company that is exlcuded on ESG (environmental, social and governance) grounds from several ethical investment funds. So, we can assume in the worst case scenario, that up to 2% of money invested in gilts, potentially goes to arms manufacturers.

Another potentially problematic area for ethical investors, is government spending on nuclear programmes. Alternatively, you may consider nuclear energy to be a necessary source of energy given the climate emergency, and this may not be a major issue for you. It is difficult to identify how much government money is spent in this area, but it is likely to be less than is spent on defence.

So how do gilts compare to other ethical investments?

There is quite a lot of greenwashing of ESG investment funds and it is difficult to make a direct comparison. Investment funds may infact hold gilts. However, some ESG investment funds with the “deepest green” credentials choose to exclude government bonds for the reasons discussed above. Some ethical funds expressly do not exlcude gilts as they state that the proportions being spent on arms and nuclear programmes is small or less than their self imposed arbitrary percentage exclusion criteria.

What about Green Gilts?

The UK government has issued several rounds of green gilts, where the money raised is designated for net zero projects. However, demand outstrips supply – ESG funds are very keen to buy these for obvious reasons and therefore the yields tend to be lower than for regular gilts. This is sometimes referred to as a “greenium” (green premium). In practice, it’s difficult to find any of these green gilts to purchase on trading platforms. In addition, the last UK governments green credentials were shaky to say the least (see Cumbrian coal mine, oil and gas licences etc.) which somewhat undermined the credibility of the last set of green gilts.

In summary

If you have money to invest and are looking for a safe investment that has the potential to beat inflation, you may want to consider investing in gilts. They are not without ethical concerns though. Consider if you would be willing for a proportion of your money to be spent on arms and nuclear projects. In particular, research the ethical track record of companies that the UK government may purchase miliatary equipment from before investing.