UK Gilt Market in Depth: Conventional, Index-Linked, and Stripped Gilts

The UK government bond market is one of the oldest and most liquid government bond markets in the world. Gilts — the name derives from the original gold-edged paper certificates — form the backbone of sterling fixed-income investing, anchor pension fund liability matching, and serve as the reference rate for pricing most other sterling assets. For international investors with sterling exposure, and for UK-based wealth holders structuring long-duration portfolios, understanding how gilts work is foundational.

What a Gilt Is

A gilt is a debt security issued by His Majesty's Government through the Debt Management Office (DMO). When the government issues a gilt, it borrows money from investors for a fixed term, paying a predetermined coupon (interest) at regular intervals and returning the face value (principal) at maturity.

The key attributes of a gilt:

• Coupon rate: the annual interest payment as a percentage of face value, paid in two semi-annual instalments
• Maturity date: the date on which face value is repaid
• Clean price vs dirty price: the traded price excludes accrued interest (clean price); the amount the buyer actually pays includes accrued interest since the last coupon date (dirty price)
• Yield to maturity (YTM): the total annualised return if held to maturity, incorporating the coupon stream and the difference between purchase price and face value

Gilt prices move inversely to yields. If a gilt is priced at £90 (below par) and matures in 10 years at £100, the investor makes a capital gain in addition to the coupon income — the yield is therefore higher than the coupon rate. If priced above £100, the capital loss reduces the yield below the coupon rate.

Conventional Gilts

A conventional gilt has a fixed coupon and a fixed maturity date. The coupon and repayment are in nominal terms — there is no adjustment for inflation. As at mid-2026, the conventional gilt market spans maturities from under 1 year to over 50 years, with outstanding gilts issued with varying coupons reflecting the interest rate environment at their time of issue.

Duration and convexity. Modified duration measures the price sensitivity of a gilt to a change in yield. A gilt with a modified duration of 15 years will, in rough terms, fall 15% in price for every 1 percentage point rise in yield. Convexity describes the curvature of the price-yield relationship: because of convexity, the price gain from a 1% yield fall exceeds the price loss from a 1% yield rise — an asymmetry that benefits holders.

The yield curve. Plotting the yields of conventional gilts from shortest to longest maturity produces the gilt yield curve. In normal conditions the curve is upward-sloping (longer maturities yield more, reflecting the greater uncertainty over a longer period). During 2022–2023, the UK gilt yield curve inverted — short-term yields exceeded long-term yields — reflecting the Bank of England's aggressive rate hiking cycle and market expectations that rates would eventually fall. An inverted curve is historically associated with economic slowdown.

The September 2022 LDI episode. The UK gilt market experienced an extraordinary period of volatility in September–October 2022, triggered by the Truss-Kwarteng "mini-budget." Long-dated gilt yields rose by approximately 150 basis points in a matter of days, forcing pension funds using liability-driven investment (LDI) strategies to sell gilts into a falling market to meet collateral calls. The Bank of England intervened with a temporary purchase programme. Long-dated gilt yields reached over 5% — levels not seen for 20 years. This episode is a reminder that even government bonds carry significant price risk for investors who are long duration.

Index-Linked Gilts

Index-linked gilts, first introduced in 1981, are distinct from conventional gilts in that both the semi-annual coupon payments and the final principal repayment are adjusted for inflation. The inflation index used is the Retail Prices Index (RPI) — the UK government chose to retain RPI for existing gilt contracts despite the statistical community's preference for CPIH.

Real yield. The yield on an index-linked gilt is a real yield — the return above inflation that the investor earns. For much of the period from 2009 to 2021, UK index-linked gilt real yields were deeply negative: investors accepted negative real yields because the assets were in high demand from pension funds seeking long-duration inflation-linked liabilities. From 2022 onwards, real yields turned sharply positive as nominal yields rose faster than break-even inflation expectations — a significant structural shift.

Break-even inflation rate. The break-even inflation rate is the implied inflation level at which an investor would be indifferent between holding a conventional gilt and a comparable index-linked gilt. It is calculated as:

Break-even inflation = Conventional gilt yield − Index-linked gilt real yield

If RPI inflation over the life of the gilt exceeds the break-even rate, the index-linked gilt outperforms. If inflation is lower than break-even, the conventional gilt is the better investment.

Why pension funds buy index-linked gilts. UK defined benefit pension schemes have long-term inflation-linked liabilities (inflation-linked pension payments to members). Index-linked gilts are the closest available asset match to those liabilities, which is why the UK's pension fund industry has historically been the dominant buyer of long-dated index-linked gilts.

Gilt Strips

Stripped gilts, commonly called gilt strips, are zero-coupon instruments created by separating (stripping) the component cash flows of a conventional gilt. A conventional gilt with 10 years to maturity and semi-annual coupons has 21 separate cash flows (20 coupon payments + 1 principal repayment). Each of these cash flows can be traded independently as a strip.

Principal strip vs. coupon strip. The principal strip (the final repayment of face value at maturity) and each coupon strip (a single semi-annual interest payment) are different instruments with different maturities. A 25-year principal strip makes one payment — £100 face value in 25 years — and makes no coupon payments in the interim.

Zero-coupon nature. Because strips pay no income, they trade at a deep discount to their face value. A principal strip with a face value of £100 maturing in 20 years, priced to yield 5%, would trade at approximately £37.70 today. The entire return comes from price appreciation as the strip approaches maturity.

Who uses gilt strips. Strips are used primarily by:

• Pension funds and insurance companies precisely matching specific future liability payments (asset-liability matching)
• Zero-coupon bond investors seeking a known nominal sum at a specific future date
• Banks and financial institutions using strips in structured product construction

Tax treatment for UK residents. Gilt strips are subject to income tax on the annual accrual of discount — even though no cash is paid until maturity. This treatment makes strips relatively tax-inefficient for higher-rate taxpayers outside a pension wrapper. Within a SIPP or other pension, the tax timing disadvantage does not apply.

The DMO and How Gilts Are Issued

The Debt Management Office (DMO) is an executive agency of HM Treasury, responsible for managing the UK national debt. It issues gilts primarily through competitive auctions.

Auction process. The DMO announces a forthcoming auction — typically one week in advance — specifying the gilt to be issued (often a new tranche of an existing gilt, reopening it to increase the outstanding stock and improve liquidity), the face value to be sold, and the auction date. Primary dealers (gilt-edged market makers, or GEMMs) submit competitive bids specifying the price (and therefore yield) at which they wish to buy. Non-competitive bids allow smaller investors to buy at the average allotment price.

Secondary market. After issuance, gilts trade in a dealer-to-dealer over-the-counter market through GEMMs, and are also accessible via most UK stockbroking platforms for retail investors. The most recently issued on-the-run gilts are the most liquid; older off-the-run gilts may be less liquid but sometimes offer a small yield premium.

Buying Gilts as a Private Investor

Computershare Investor Services. The UK Registrar and Transfer Office (now operated by Computershare) operates a retail gilt purchase facility, allowing UK-registered investors to buy gilts directly without a stockbroker. This is cost-effective for very small amounts but operationally clunky and not suitable for active management.

Via a broker or platform. Most major UK stockbroking platforms (Hargreaves Lansdown, AJ Bell, Interactive Brokers, interactive investor) allow direct purchase of gilts on the secondary market. Gilts can be held in a stocks and shares ISA, within a SIPP, or in a general investment account. For higher-rate taxpayers, holding gilts in an ISA shelters the coupon income from income tax.

Gilt funds and ETFs. For investors not wishing to manage individual gilt positions, index-tracking gilt ETFs are available:

• iShares Core UK Gilts UCITS ETF (IGLT)
• iShares £ Index-Linked Gilts UCITS ETF (INXG)
• Vanguard UK Government Bond Index Fund

These provide diversified exposure across maturities and are appropriate for most private investors.

Gilts in an Investment Portfolio

Gilts fulfil three distinct roles in a diversified portfolio:

1. Safety. As UK government obligations denominated in sterling, conventional gilts carry no credit risk (the government controls the currency). They are the safest sterling asset.
2. Interest rate sensitivity. Long-dated gilts are very sensitive to interest rate changes and can generate significant capital gains in a rate-cutting environment. In 2023, as markets began to price in Bank of England rate cuts, long-dated gilts rallied substantially.
3. Deflation hedge. In a deflation scenario, nominal gilts outperform because their fixed cash flows are worth more in real terms, while the real yield on index-linked gilts may fall if inflation expectations collapse.

The extent to which gilts serve as a portfolio diversifier depends critically on the correlation between equity and bond returns. When inflation is the dominant market driver, equities and gilts tend to move in the same direction (both fall when inflation rises and rates go up) — undermining the 60/40 logic. When growth risk dominates — a recession environment — gilts tend to rise as equities fall, restoring the diversification property.

Compliance Notes

Gilt prices move inversely to yields and can fall significantly in a rising interest rate environment, as demonstrated in 2022. Past yields and returns are not a guide to future performance. Index-linked gilts' real returns depend on actual realised inflation relative to market expectations at the time of purchase. The tax treatment of gilt strips is complex for individuals and should be confirmed with a tax adviser. This guide is for information only and does not constitute financial advice.

How Global Investments Can Help

Gilts and fixed income form part of many client portfolios, particularly for those with sterling liabilities or approaching drawdown. We can advise on appropriate gilt allocation within the context of your wider portfolio objectives and help you access the market via the most appropriate vehicle for your tax position. Contact us to discuss your fixed-income requirements.