UK gilts are bonds issued by the UK government for the purpose of financing the shortfall between public spending and tax revenues and there are a number of different types of UK gilts currently in issue.

UK gilts are very highly rated by all of the main credit ratings agencies (AAA as at November 2012) and the prices to buy gilts fluctuate on a daily basis during market trading, mainly based on the outlook of the interest rates. All UK gilts are unconditional obligations of HM Treasury and before investing in them, it is very important that you are aware of the various types and their unique features.

Conventional Gilts

Conventional gilts are the most common type of UK gilts, accounting for just over 81 per cent of outstanding UK government debt. These gilts guarantee to pay a fixed cash coupon to the holder two times a year and at maturity, together with repayment of the nominal amount of the gilt.

Conventional gilts can extend as long as 50 years or be as short as just a few months. The dates are generally categorised as follows:

• Ultra-Short dated gilts - maturity in 3 years or less
• Short dated gilts - maturity from 3 years up to 7 years
• Medium dated gilts - maturity from 7 years to 15 years
• Long dated gilts - maturity over 15 years

For the private investor, the most popular length of investment will normally be between 2 years and 10 years. A small number of these conventional gilts feature more complicated aspects, such as calls that let the UK government pay off debts well ahead of time.

Perpetual or Undated Gilts

The main difference between perpetual or undated gilts and conventional gilts is the lack of a maturity date. These UK gilts were issued with no set maturity date, and they can be paid back at the discretion of the UK government. These are the oldest gilts within the UK gilts portfolio and because they are so old, they have very low coupons, making it less attractive to the government to redeem them, as they are receiving cheap borrowing.

Due to this unique aspect of these UK gilts, the holder is dependent on the market price if they decide to liquidate their investment and perpetual or undated gilts should therefore be considered riskier than conventional gilts. They also tend to be more volatile than conventional gilts, with the most popular among them being the UK 3.5 percent War Loan, which still has £1.9bn in issue.

Index-Linked Gilts

Issued for the first time back in 1981, index-linked gilts are different from conventional gilts due to the way that the coupon payments and principal are calculated. Rather than these being a fixed amount, set at the date of issue, both the principal and the semi-annual coupon payments are adjusted with reference to the RPI, or the General Index of Retail Prices in the UK.

Since September 2005, there has been a 3 month time lag on the RPI used in the calculation of indexation on the coupon and the principal. This was an 8 month indexation lag on gilts issued before that date. These investments provide a shelter against the threat of inflation and it is not uncommon for these gilts to display a greater price movement over time, mainly because of this inflation-linking factor.

As with any investment, it is always advisable to fully research and understand the complete details of the issue before investing. Prospectuses for any UK gilts issues can be found on the website of the UK government’s Debt Management Office.