Fixed income popularity jumps

• Holdings in fixed income investments on interactive investor (ii) have nearly tripled over the past two years, with direct gilt assets up nearly 21-fold
• Investors are tapping into inflation-beating yields and attractive tax breaks on gilts
• Capital gains could also be around the corner, as the Bank of England readies for a rate cut as inflation falls.

New data from interactive investor (ii), the UK’s leading flat-fee investment platform, reveals that the amount of money held in fixed income - across dedicated bond funds and direct holdings such as gilts - has risen nearly three times in the past two years among customers of ii. 

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Fixed income holdings are up 195% since 30 June 2022, two years ago. When we include money market funds, which invest in bonds as well as money market instruments like bank deposits, holdings are up 247% over the same period. 

Investors are tapping into higher yields

Sterling investment grade bonds yield around 5.5% if held to maturity, with funds offering similar levels of income. Gilts yield less at between 4% and 5%, but come with the backing of the UK government, which has never defaulted on its debt, as well as tax benefits as there is no capital gains tax to pay. Yields are above the current inflation rate of 2%.

Assets held in direct gilts are up nearly 21-fold (2,019%) since 30 June 2022. The most popular gilts are TN25, T26, TN28, TR25 and T26A.

These are all bonds maturing soon, and with the exception of TR25, have low coupons and trade a discount to their £100 par value. This means that most of the return comes from the difference between the price paid for the bond and the return of the £100 principal at maturity, rather than from coupon payments. Capital gains are tax free on gilts, whereas coupons are taxed as income. 

With interest rates on the cusp of falling around the world, investors could also see capital gains from their bond positions. When rates fall, bond prices tend to rise as the fixed income they offer becomes more valuable. They can therefore behave as a diversifier to equities in a portfolio, bolstering income and capital when stock markets drop and central banks step in to simulate economies. 

The five most-popular bond funds by assets held, as of 30 June 2024 are: iShares Core UK Gilts ETF GBP Dist (LSE:IGLT), Vanguard Global Corp Bond Index, Royal London Sterling Extra Yield, Invesco Monthly Income Plus UK and iShares Core £ Corp Bond ETF GBP Dist (LSE:SLXX).

The top Investment Association (IA) sectors by assets held are: £ Strategic Bond, £ corporate bond, UK gilts, Global Mixed Bond, USD Government Bond.   

Commenting on the new data, Sam Benstead, Fixed Income Lead at interactive investor, says: “The appeal of bonds for retail investors has shot up as yields have risen. While more money flowing into gilts made up the bulk of this increase, investors also added cash to corporate bond funds across a range of sectors. Investors are now finally getting paid a good income from bonds, with gilts yielding more than 4% (if held to maturity) and investment grade sterling corporate bonds offering about 5.5%.

“Gilts maturing soon, with low coupons, have been very popular. Gilts have a special tax status: while their coupon income is taxed as income, capital gains are tax-free. Because a large part of the total yield from low coupon gilts issued when interest rates were near zero comes from the capital uplift when the bonds mature, they are a useful tool to pay less tax on investments held outside of tax-efficient wrappers, such as SIPPs or ISAs. 

“Bonds are also better portfolio diversifiers today than they were before interest rates began to rise. In the event of an economic shock, central banks now have capacity to cut interest rates to stimulate the economy, which should be good news for bond prices.”

Most-popular gilts and key data

Source: interactive investor, Tradeweb, 30 June 2024.