Where should cautious investors put their money with £80 billion of short-dated gilts set to mature?

The bond market is set to be shaken in the coming months with billions of pounds worth of short-term gilts set to mature.

Many investors flocked to the safety of short maturity or low coupon gilts in the aftermath of the mini-Budget in 2022 and also as the Bank of England hiked interest rates in 2023.

The asset class has provided comfort for cautious investors amid economic uncertainty.

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Earlier this year, 10-year government bond yields hit their highest levels since 2008 this year due to concerns about the UK’s economic climate.

But research by investment firm Abrdn highlights that £80 billion of short-dated gilts are set to expire in the first six months of 2025.

That creates an issue for investors looking for somewhere else to park their money.

The difference now is that short-term yields are lower than a couple of years ago, raising questions about where investors should put their money if they want some security.

Mark Munro, co-portfolio manager of the Abrdn Short-Dated Enhanced Income Fund, said: “In recent times, thousands of people bought UK government bonds as rates rose. It has likely been a good strategy but there are two reasons that this trade is much harder to replicate moving forward.

“Firstly, despite the increase in yields globally since September 2024, yields available on low coupon gilts are now anything from 1% to 1.5% lower than their peak in 2023 and below the magical 5% figure.

“Secondly, two low-coupon gilts mature this year, equating to £80 billion, which means the availability of suitable short-dated gilts is disappearing.”

What is a low coupon gilt?

A low coupon or short-dated maturity gilt is a government bond that is set to mature soon.

They pay a fixed yield for a few years. The yield is typically lower than longer-dated yields as you may only be putting your money away for a couple of years.

But investors get certainty, plus the gilt is often discounted on the secondary market, making it cheaper to buy than the original issue value.

Munro added: “The surge has been driven by a number of factors including the attractiveness of short-dated gilts trading at a discount to their redemption value.

“This should mean that investors holding to maturity make a profit – which for a gilt is exempt from capital gains tax.”

But he warns that now that billions of short-dated gilts are expiring, investors should think carefully about what to do with their cash next.

Demand for gilts remains high, even if the pricing isn’t as attractive.

Investment platforms such as AJ Bell, Hargreaves Lansdown and interactive investor have all reported a rise in demand for gilts in recent years.

In January, Hargreaves Lansdown reported that the number of trades and amount of assets invested in gilts was 75% higher annually, while trades rose 93% on a monthly basis.

These figures were the highest it has seen since 2021, overtaking previous peaks for number of trades in October 2024 and amount of assets in February 2024.

Is it worth backing short-dated bonds?

Bond investors need to decide if they want to remain cautious or if they are ready to take more risk with equities.

The current two-year gilt yield is 4.2% and while this beats inflation, you may earn more in an easy access account where you can withdraw your money when you want it.

Philip Dragoumis, director at Thera Wealth Management, said buying low coupon gilts directly can still be very tax efficient especially for higher or additional rate tax payers as they are free of capital gains tax.

He added: “UK bonds currently continue to offer yields above inflation, act as a diversifier and a hedge against a possible recession.

“Investors who prefer lower volatility should look at short-dated bonds or funds, those with higher risk profiles and longer investment horizons can incorporate more volatile longer dated or inflation linked bonds into their portfolios.”

But Ross Lacey, independent financial adviser for Fairview Financial Management, suggests investors should first consider why they invested in the gilt in the first place.

He added: “In our experience, some investors held short-term gilts with the intention of holding to maturity as this coincided with a time at which they'd need the maturity value for something specific - eg. a tax bill or mortgage overpayment.

“They were not necessarily cautious investors, but rather those that identified the post-tax return on the gilt were more attractive than sticking the money in a savings account. For investors looking to target longer term growth, with a fighting chance of maintaining their purchasing power, gilts will unlikely be the answer.”