How to choose a UK Gilt ETF

UK Gilt ETFs, and bonds in general, are in need of a hug. They had a miserable time in 2022, prompting some financial seers to suggest the impending annulment of the popular stocks/bonds marriage.

Is that fair? Or are the usual suspects again overreacting to an isolated market wobble? Bonds are still one of the safest and easiest ways to diversify and stabilise your portfolio, and ETFs make it simple. Below we look at the best gilt ETFs on offer.

What is a gilt?

Gilts, or gilt-edged securities, are the UK’s name for government bonds. They are basically IOUs issued by the government: you lend them some money for a certain amount of time and they promise to pay you back on a certain date, along with a bit of interest (the yield) along the way.

Back in the day, paper bond certificates issued by the Bank of England had a fancy gilt (gilded) edge – hence the name. King William III was the first to go cap-in-hand to the citizenry when, in 1694, he sold £1,200,000 worth of bonds to fund his righteous foray against the French in the Nine Years’ War.

These days, the government issues gilts to help pay for all the things it needs to spend money on like hospitals, roads and schools, and also the wine and cheese for its illegal lockdown parties.

UK gilt price carnage

My guiding principle is this: [Gilts are] never to be doubted.

Franz Kafka*

After two decades of polite disagreement, stocks and bonds went all Bonnie and Clyde in 2022. Instead of continuing their usual trend of mostly doing the exact opposite of one another, they linked arms and sang Abide With Me as the chilly waters of financial ruin lapped about their ankles.

Some all-knowing oracles of financial punditry are proclaiming that the markets have fundamentally changed. “Strategies that worked before will no longer be viable in this new investment landscape,” crow the asset managers desperate to justify their fees.

Those with a longer view know that the only reliably predictable thing about the financial markets is their unpredictability. Bonds are still an important diversifying element of a portfolio. For UK investors, Gilt ETFs are a great option.

Are gilts still a good investment?

Despite the carnage of 2022, bonds still play an important role in diversifying your portfolio. For the first 20 years of this century, bonds tended to move in the opposite direction to stocks, especially during market crises, which made them extra good at smoothing returns. They were like a Xanax for your portfolio, taking the panic down a notch when the stock market was hysterical.

Has that changed? Probably not. My crystal ball is out of batteries but, historically speaking, 2022 was very unusual. It’s only the third time since 1871 that both stocks and bonds have finished negative over a calendar year, and it has never happened to such a degree.

Is this time different? Nobody knows. What we do know is that one year’s worth of data is never enough to make rash judgements about the future of the financial markets, and government bonds are still inherently less risky than stocks.

Even if they do tend to move more in line with the stock market in the future (as they have for most of history), they will still reduce portfolio risk through dampening volatility and increasing diversification. The Xanax Effect will likely still play out in times of crisis, since money tends to rush to safety when the stock market tumbles.

The best UK government bond ETFs

There is fundamentally little difference between the four major players in the UK Gilt ETF market. The IShares Core UK Gilts ETF (IGLT) is the biggest by a fair margin, followed by the Lyxor Core UK Government Bond ETF (GILS). The latter is the cheapest for now, but a 0.07% annual charge is slated for 2024.

Bond ETFs measure themselves against whichever index they try to mimic. This is known as benchmarking. In this case, the IShares and Lyxor ETFs try to follow the FTSE Actuaries Gilt Index, whilst the Vanguard (VGOV) and the SPDR (GLTY) variations are beholden to Bloomberg’s versions of the same thing.

Despite the difference in benchmarks, there has been little variation in performance. As you can see from the following chart, they have been holding hands through thick and thin for the last five years and were all thumped to the same degree in 2022.

So does it matter which of these ETFs you choose? They are all large funds from major players in the ETF market, so they will likely meet the core bondage needs of your portfolio. The SPDR is more expensive, which may be something you want to bear in mind, but really they are all good options.

As with much of the ETF universe, the choice is often a false one. The major funds all basically do the same thing – they are merely a product of different investment houses claiming a piece of the ETF pie. Your choice may simply come down to whatever is offered by your platform. Most will offer all four, but if your account is with Vanguard then VGOV will be your best bet, but they do have one non-ETF option which may be of interest.

Vanguard UK Government Bond Index Fund

This fund is almost identical to the Vanguard UK Gilt UCITS ETF, only it is an index fund rather than an exchange-traded fund. The important difference for hands-off, long term investors is that it offers an accumulating version, which automatically reinvests the dividends for you. The ETFs listed above are all distributing funds, so the dividends will be paid to you as income.

The choice will come down to personal preference. Performance-wise, the two Vanguard options are almost identical. The index fund is slightly more expensive with an annual charge of 0.12% vs the 0.07% cost for the ETF. Often the choice comes down to an investor’s tax obligations – it might be helpful to read over our guide to the UK’s treatment of tax when it comes to ETFs.

A steady hand at the tiller

There is nothing sexy or exotic about these funds, making them excellent options for a core bond holding. Whichever you choose, you’re unlikely to end up with buyer’s remorse somewhere down the line.

Bonds still have an important part to play in diversified investment portfolio, despite the wailing and gnashing of teeth brought on by 2022’s shenanigans. UK gilt ETFs don’t provide the geographical diversification of a global bond ETF, but for UK investors they are still a great option.

* Close enough.