(Bloomberg) — Investors are preparing for a flood of retail cash to hit the gilt market after the redemption of a UK bond that has become popular among wealthy Brits looking to lower their tax bill.
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The £36 billion ($45 billion) bond maturing Friday has an unusually low coupon and offered higher effective returns than savings accounts for wealthy private investors, thanks to quirk in UK tax policy. It became the most sought-after gilt for retail traders.
Investors will likely roll much of the redeemed cash into other low-coupon gilts maturing in the coming years, according to RBC Capital Markets strategists including Megum Muhic. Two such securities maturing in 2026 both surged Thursday ahead of the redemption.
“A lot of cash is about to be deposited into customer accounts and could be looking for a new home,” said Sam Benstead, fixed-income lead at interactive investor, an investment platform with over £70 billion in assets under administration. “The timing is good for investors looking to reinvest this cash into short-term gilts, as yields have risen since the summer.”
The gilt in question was first sold in mid-2021 when the UK economy was recovering from the coronavirus pandemic, the Bank of England’s key rate was at a record low 0.1%, and the prospect of meaningful monetary tightening remained remote. That means its semi-annual coupon, which the nation’s Debt Management Office sets in line with market yields at the time of issuance, is just 0.25%.
Low-coupon securities are appealing to retail investors because, while gilts are exempt from capital gains tax, income tax is still due on the coupon income. That means that holders can realize larger tax-exempt returns as they gravitate toward their redemption value compared to higher-coupon peers.
“These gains can be significant given the distance from par that some of these bonds have traded,” said Moyeen Islam, a rates strategist at Barclays Plc. The 2025 gilt maturing Friday issued at 100 pence in June 2021 slid below 90 pence in 2022, before bouncing back to its redemption value.
“Anecdotal evidence suggests that retail holdings for some bonds can be surprisingly high and the recent selloff has seen strong demand from retail investors,” Islam added.
Low coupons also offer benefits to institutional investors due to their higher sensitivity to moves in interest rates, allowing fund managers to adjust their portfolio risk more efficiently. At the DMO’s annual consultations last week, there were calls from some market participants for greater supply of low-coupon securities.
