Bond Watch: the two gilts investors have been snapping up

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

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Here’s what you need to know this week.

Rise in yields attracts gilt buyers

Our latest Private Investor Survey, which tracks what ii customers invest in, showed that gilts are becoming more popular.

For the first time since the survey launched in January 2020, some gilts are in the top 10 most-bought investments.

Two gilts broke into this exclusive list, held by customers aged 25-34 and 35-44, in quarter three of 2023: TN25 and TN24.

TN25 matures on 31 January 2025 and TN24 matures on 31 January 2024. Both bonds have low coupons and trade close to par, meaning that the vast majority of their returns will come from capital gains on maturity, which is tax free. They yield around 5% if held to maturity.

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Portfolio weightings to bonds have also crept higher. Customers with allocations to instruments in the ‘other’ category (meaning fixed income and corporate bonds) was just 0.6% in Q1 2021, 0.8% in Q4 2022, increasing to 2% in Q3 2023.

Bonds higher up the risk spectrum, including investment grade and high yield corporate bonds, yield even more. Nevertheless, bonds are not risk free. While the income from gilts and the return of their principal is secure, their prices can still be volatile, particularly those with a long time before maturity.

Investors re-price bonds based on their expectations for interest rates and inflation, so an unexpected rise in interest rate expectations can spook the bond market, sending prices down and yields higher.

The best-performing bond sector this year

Bond markets are having a difficult year, as interest rates keep rising and are now forecast to stay higher for longer.

But one part of the market is thriving: catastrophe bonds. Also known as “cat” bonds, they are issued by insurance companies to help them cover the costs of natural disasters. If no catastrophe occurs, the insurance company pays a coupon to the bond owner.

But a catastrophe, such as a flood or earthquake, means that insurance companies do not have to pay back the amount borrowed, helping them cover the costs of paying out to their clients. They are often structured as floating rate bonds, where rising interest rates lead to rising coupons. Effectively, they allow insurers to pass the risk of a catastrophe onto investors.

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Bloomberg reports that it is the best-performing bond market in the world this year. One fund on the ii platform investing in the sector is GAM Star Cat Bond, which has risen 13% in 2023. It currently yields 8%. The fund and sector has been benefitting from the lack of natural disasters as well as rising interest rates globally.

However, GAM warns that the fund’s value may “fall significantly” and “not recover” in the event of  natural disasters.

Not for the faint-hearted, but an interesting part of the fixed income universe nonetheless for adventurous bond investors to do further research.