Types of Bonds in the UK: A Comprehensive Guide

This comprehensive guide covers the different types of bonds that are available in the UK. We discuss bonds, gilts, treasury bills, corporate and government bonds to give you a broad overview of the bond market. The research is based upon insights from financial experts and other financial institutions. This content is for informational purposes only and should not be construed as investment advice. 

Key Takeaways 

• Government bonds offer a lower risk profile compared to corporate bonds. 
• Treasury bills are short-term bonds with a maturity of 1, 3, or 6 months. UK gilts have medium to longer-term maturities from 2 to 50 years.  
• Corporate bonds help finance businesses and their projects, while government bonds are use to finance government operations such as public services and infrastructure.  
• There are various specialised bonds, such as green bonds, zero-coupon bonds, and perpetual bonds that each have a different purpose.  
• Admiral Markets offers a wide variety of bond ETFs (exchange traded funds), enabling broad exposure to government, high-yield and corporate bonds. 

Government Bonds 

Government bonds are bonds issued by countries to finance projects such as public infrastructure or to fund budget deficits. As they are backed by the government, the probability of default on loans is very low, which is why they are considered to be a lower risk investment compared to corporate bonds and stocks.

Gilts

Gilts are bonds issued by the UK government. They have a fixed interest rate (coupon payment), which is typically paid every 6 months and a fixed maturity period.  

Maturity: Short, Medium, and Long-Term Options  

Gilts have different maturity dates, which means that every single type of gilt has a different investment horizon. This serves as an opportunity for investors to find the right options for themselves. Investing in gilts involves risk, and the value of your investment may go up or down.

Short-term gilts regularly mature within one and five years after the day of issuance. Interest rates are typically lower on these bonds because of the shorter maturity; however, they are much more liquid than gilts with longer horizons.

Medium-term gilts range between a maturity of six to fifteen years. These tend to have higher yields than short-term gilts.

Long-term gilts have maturity dates of sixteen to fifty years. They offer the highest interest rates because they are sensitive to changes in macroeconomic factors such as interest rates and inflation. There is also a need to be more value for an investor to tie up their capital for such a long period of time. 

Index-Linked vs. Conventional Gilts  

Conventional gilts are regular gilts that offer a predetermined fixed interest rate. While they are the most stable type of gilt, investors risk lower real returns on their investment if inflation is rising.

Index-linked gilts offer interest and principal payments that are linked to the inflation of a country. The inflation protection ensures that the purchasing power of money is not heavily affected, although it is difficult to determine the direction of inflation. 

Auction Dates and Liquidity  

UK government gilts are auctioned by the UK Debt Management Office. Investors can also invest in gilts in the secondary market like the London Stock Exchange, where you purchase gilts from other investors.

Gilts tend to have high liquidity but with larger price fluctuations due to the changing expectations of interest rates.

Treasury Bills  

T-bills are debt securities with low maturity; hence, they are intended for short-term project financing. T-bills are known as zero-coupon bonds as they do not pay any annual interest. The return on investment is covered by the difference in the buy and sell price of the bond. T-bills are low-risk investments, but they are still subject to market fluctuations and investor-specific factors. 

Maturity: 1 – 6 Months  

T-bills have a short investment horizon. Maturities of treasury bills are typically 1, 3, or 6 months. It allows investors to pursue their short-term financial objectives and liquidity needs while not taking too much risk.

Discount Rate and Issuance Method  

Since no coupon is paid, bonds are sold at a discount. The investors purchase bills at low prices and recover the face value on the expiry of the bond. The return is based on the price the T-bills were sold at and what they are redeemed for (face value).

Minimum Investment and Risk Level  

When buying treasury bills, you have to take into account that there is a minimum investment amount that will differ depending on the intermediary used for purchasing. T-bills have limited default risk because they have backing from the UK government, which is unlikely – but not impossible – to go bankrupt.

Corporate Bonds  

Corporate bonds are investment products that are issued by companies to fund their operations. Comparing them to governmental bonds, these bonds are riskier because of the higher chance of a company not being able to pay back its loans.  

Investment Grade Bonds  

Investment-grade bonds are corporate bonds from companies with strong credit ratings. This implies that these companies are not likely to default on their obligations.

Risk Level: Lower  

The investment-grade bonds are among the lower-risk investments of corporate bonds. They are slightly riskier than government bonds but still offer more stability and safety than other high-yield bonds. Of course, there is always a risk in any form of investing.

Liquidity and Rating Agencies  

The liquidity of investment-grade bonds is generally high. The creditworthiness of the bonds is assessed by rating agencies such as Moody’s, S&P, and Fitch. A rating represents high creditworthiness, while C and D ratings represent lower creditworthiness.  

Examples: Large UK Companies  

The UK's largest multinational companies offer investment-grade bonds. Companies such as BP and Unilever will offer bonds to use capital to finance their operations. In return, the investor is paid a fixed interest rate or coupon rate.

High-Yield Bonds  

High-yield bonds are issued by companies that don’t have high credit ratings and are still prone to factors that could make their business operations more difficult. The high-yield bonds can, for instance, be issued by startups seeking funds to get their business off the ground.

Risk Level: Higher  

The risk level is significantly higher for high-yield bonds than for other corporate bonds. Due to the high risk of default, investors face high price volatility and potential losses. 

Liquidity and Default Risk  

The liquidity of high-yield bonds is often lower than with other mainstream debt vehicles. As there is a higher likelihood of default, there is generally a lower demand for these bonds, especially when the company is not doing well. In that case, it can be hard to sell the bonds in question.  

Examples: Smaller, Less Established Companies  

One of the examples of a company that offers high-yield bonds is Pizza Express. Rating company Fitch revised Wheel Bidco Limited's (Pizza Express) outlook to negative from stable, providing a default rating of B-. The company previously issued high-yield bonds to refinance its debt, and it was six times oversubscribed due to the high yield.  

Other Bond Types  

Nowadays, there are various specialised bonds that are designed to serve specific purposes and have different features.  

Index-Linked Bonds  

Index-linked bonds are linked to inflation. They intend to try and protect investors from losing value because of increasing inflation.  

Inflation Protection and Principal Adjustment  

The principal value and the interest payment adjust as inflation changes. In this way, the purchasing power of the money remains unaffected.  

Coupon Payments Linked to Inflation  

The annual interest payments adapt to the inflation rate in the UK. Indices such as the Retail Price Index and the Consumer Price Index are used to determine the inflation rate and adjust the interest payments.  

Examples: Index-Linked Gilts  

The government in the UK issues a large number of 3-month index-linked gilts that are revised daily, based on the most current inflation percentage.  

Zero-Coupon Bonds  

Zero-coupon bonds are debt vehicles that do not pay any interest payments. The structure forces the investors to make their return purely from the difference in the current price of the bond and the face value at redemption.  

Discount and Maturity Value  

To be able to still make a return, these bonds are sold at a discount. In that way, investors can benefit from the difference between the price of the bond when buying it and the price they get when it is repaid.   

No Regular Interest Payments and Accrued Interest  

Because you can benefit from the difference in prices, the investor does not need interest payments in order to make a return on the investment. Without standard coupon payments, the interest accrues over the lifetime of the bond and is paid at the maturity date.  

Green Bonds  

With a rise in more sustainable investment practices, green bonds have grown in demand.  

Environmental Projects and Sustainability Goals 

The main objective of green bonds is that investors can align financial performance with ESG (environmental, social and governance) goals. Investing in green bonds helps finance projects in renewable energy and other sustainability products.  

Issuers: Corporations and Governments  

By far the highest amount of green bonds is currently issued by the UK government. Corporations like Thames Water Utilities and DS Smith also issue a large amount of green bonds.  

Green Bond Principles and Impact Reporting  

The Green Bond Principles is a set of rules that a fund should follow to ensure it is a transparent and reliable investment vehicle that positively impacts the climate.  

Perpetual Bonds  

Perpetual bonds are specific types of bonds that have no maturity date. The principal amount will thus never be repaid, but the interest payments keep on coming until eternity.  

No Maturity Date and Call Option  

While there is no maturity date for these bonds, the investors often still get a call (buy) option which allows them to redeem the bond at a certain date.  

Fixed or Variable Interest Rates  

As an investor, you can choose between perpetual bonds with fixed or variable interest payments. While fixed payments offer stability, the variable payments typically protect you from the value loss of your money, due to things like inflation and interest rates.  

Risk: Issuer's Solvency and Examples (Consols)  

The main point of interest with perpetual bonds is the solvency of the company that issues the bond. If the solvency is low, it is riskier to commit to a long-term bond. An example of a perpetual bond that is not available anymore is a consol bond. The consols were issued with high fixed interest rates. When the interest rates started falling, this way of financing became expensive, so the government stopped issuing them.

Conclusion 

Choosing which bonds to invest in can be a difficult process. This guide provided a broad overview of the different bonds available and their risk profiles. Another option available to investors is to purchase bond ETFs (exchange-traded funds).

Bond ETFs 

A bond ETF is a fund that invests in many different bonds (corporate or government). An investor can purchase shares of the bond ETF and then gain broad exposure to the performance of all the bonds held within the fund. A bond ETF is listed on a stock exchange, and investors can buy or sell shares in it like they would a regular company stock.  

By searching for ‘bond’ in the Admiral Markets Contract Specification page, you can view a list of various types of bond ETFs available. You can also invest in these using a demo account. This allows you to invest and trade in a virtual environment to learn more about the risks involved before using a live account.  

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