Why isn’t everyone rushing to buy gilts?

Am I missing something? Why do I not read more about UK government gilts and their attractions? They are easy to buy with what are, for now, good rates of interest with 100% security.

AM, Surrey

While there has never been an investment you can totally forget about, that is never truer than today. Gilts — or government bonds — are no exception: the further you look into them, the trickier they appear.

As you say, rates on gilts look competitive at about 3.96% over 10 years but they are not risk-free. Gilts do well when inflation is low and the pound is stable or strengthening. Neither of those conditions is likely to last throughout the life of a medium-or long-term fixed interest stock. And if, like most investors, you want to sell before a gilt matures, you may get less than you think you should.

Because interest rates have fallen so far, many gilts are trading at above their £100 maturity value. That means that if you hold them to the end of their life, you will face a guaranteed loss to set against the interest you will have received. And if you sell before maturity, you run the risk that prices are lower given the huge supply of gilts likely to come on to the market to fund the government’s deficit.

At the moment, the Bank of England is a constant buyer of gilts, supporting the price in the short term. But once that ends, prices will be depressed by the glut, the predicted threat of inflation and higher interest rates. In addition, where gilts are not held within a pension or Isa, the interest will be taxed at an investor’s highest rate.

Jason Butler of Bloomsbury Financial Planning said: “My advice is to tough it out until cash rates improve. You may not get the highest yield but you’ll avoid seeing a large chunk of your capital disappear when interest rates and inflation eventually rise.”

You should compare gilts with other investments. Are you willing to give up a little security for the sake of a potentially much higher return? Take Tesco shares, which do not carry 100% security but are not far off. They yield 3% and the dividend and share price should gradually grow. Or you could spread your risk by buying into a corporate bond or equity income fund.

Andrew Wilson at Towry Law, the adviser, said: “You have to consider how much of your wealth you really want to lend to the government — and how much you want to be invested in sterling-denominated assets.”

A thoughtfully assembled portfolio should contain some gilts, just as for many people it should contain some gold. But I wouldn’t want all my money in either.

The financial compensation limit of £50,000 in the event of bank failure is well publicised, but what is the position with savings invested through companies like Bestinvest [which uses the Cofunds funds platform] or Hargreaves Lansdown? To the extent that these are intermediaries, presumably the risk lies with the final investment, which might be a unit trust? Does the £50,000 compensation in the event of company failure then also apply to companies such as Fidelity, Blackrock and Invesco?

IC, South Yorkshire

Your confusion is understandable. The Financial Services Compensation Scheme (FSCS) rules and limits for deposits are slightly different from those applying to investments. Let’s hope that when the dust has settled on the financial crisis the position can be simplified.

As you say, up to £50,000 is payable when an authorised deposit-taker is unable, or likely to be unable, to repay its depositors.

The ceiling for compensating investment losses is £48,000, made up of all the first £30,000 loss and 90% of the next £20,000. It’s a crazy formula, dating from when £50,000 was a substantial sum, and it is triggered when an authorised investment firm cannot meet claims against it.

However, banks and investment firms are not completely insulated from one another. If you send an investment firm money to buy shares, and that money is temporarily deposited in a bank, you will receive £50,000 if the bank defaults. However, if your money has been spent on shares that you then order sold and the adviser goes bust before the cash reaches the bank, the £48,000 limit applies.

The FSCS rules make no distinction between a unit trust management firm and an investment adviser. Whether you would be entitled to compensation would depend entirely on where your money was at the moment when a firm defaulted. Bear in mind, though, that your money would normally spend much more time in a fund manager’s account than an adviser’s. And fund managers are legally compelled to put their clients’ assets in the hands of an independent trust or depository company.

Adrian Lowcock of Bestinvest said: “It is unlikely investors would lose money if the underlying investment company goes bankrupt, as investors’ money in unit trusts and Oeics [open-ended investment companies] is ring-fenced and held separate to the business.

“If Cofunds failed, for example, it is also unlikely investors would lose out, as this company acts as a nominee and therefore investors would also be ring-fenced. Bestinvest does not hold client monies and therefore there is no risk to your money.”

Daniella Johnston of Cofunds added: “If an investor holds an investment with a fund group, bought through Cofunds, and that group ceases, the consumer would be entitled to compensation of up to £48,000. FSCS also covers an investor holding cash on the Cofunds platform in the same way.”

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