What caused UK retail’s tilt to gilts?

UK retail investors have not, historically, been the biggest fans of gilts. Which is lucky, because 2022 — the year inflation hit double digits, Liz Truss was forced from office, and the Bank of England had to step in to stabilise the market — was an absolute shocker.

In the aftermath of the mini-Budget, however, a variety of factors conspired to make gilts a more appealing investment.

For one thing, yields were a lot higher. For another, it became widely understood that low-coupon gilts could be used by UK taxpayers as a way to get high after-tax interest rates on their savings.

Higher rate UK taxpayers can get tax-adjusted hold-to-maturity returns on low-coupon gilts that are higher not only than those attached to high-coupon gilts, but in many cases higher hold-to-maturity returns than even junk-rated corporate bonds.

This is because gilts are capital gains tax exempt in the UK, while junky corporate debt tends not to be. And because low-coupon gilts trade below — sometimes far far below — par, but mature at par value, the price appreciation portion of their yield to maturity that comes tax-free can be chunky.

The result is that low-coupon gilts are actually much more valuable to UK taxable investors than high-coupon gilts.

Has this caused taxpaying retail investors to pour enough money into the market to screw with the UK yield curve? Alphaville asked this question back in 2024. We found that low-coupon gilts traded at lower yields than equivalent maturity high-coupon counterparts, so maybe? Here’s how the curve looks today:

Unfortunately, data on retail flows is hard to source. And bond geeks at institutional funds muttering under their breaths about the “convexity benefits” of low coupon bonds mean the kinkiness of the gilt curve is hard to pin entirely on retail.

However, yesterday the Bank of England jumped into the retail gilt phenomenon. Sarah Munson, from the central bank’s Sterling Markets division, and Callum Ashworth, from its Market Intelligence and Analysis division, used transaction-level data required under Mifid II to establish quite how big a presence retail has become. 🥳

Amazingly, they found that retail buyers now own close to all of the free-float of the 0.125 per cent gilt maturing at the end of January (stripping out BoE QE portfolio holdings), and close to half of a couple more:

According to the researchers:

Retail demand has been concentrated in a small number of gilts. Holdings tend to be in ultra short-dated bonds that mature within the next three years (see Chart 1). In addition, holdings tend to also be focused on gilts that have a low coupon, ie government bonds that pay a relatively small amount of interest to the bond holder each year, with over 80% of estimated retail gilt holdings being within the bottom quartile of available coupon rates.

What could possibly have catalysed this sudden tilt to gilts among the British taxpayers? We’ve no clear way of knowing, but here’s an annotated graph with some useful contextual information: