Anglo-South African asset manager Ninety One calls for portfolio rebalancing, as the gilt premium fades.

The once-compelling trade into low-coupon, short-dated UK gilts is showing signs of fatigue. Falling yields and maturing inventory are undermining its tax efficiency for higher-rate taxpayers, a UK wealth manager says.

John Stopford, head of managed income and Jason Borbora-Sheen, portfolio manager at Ninety One have noticed a change in the attractiveness of this end of the gilt market, they said in a note. 

For the last 18 months, low-coupon, short-dated gilts presented an unusually attractive opportunity for UK investors in the 45 per cent income tax bracket. Their exemption from capital gains tax at maturity meant that such bonds delivered post-tax returns that far outstripped most fully taxable income assets. At its peak, the tax benefit was so pronounced that an investor would have needed a pre-tax yield of 8 per cent or more from a taxable alternative to match the return on certain gilts. “But the tide is turning,” Borbora-Sheen and Stopford said.

The comments are a reminder that asset location – which, for example, can relate to tax and the structures used to deploy an investment – can be as important as asset allocation in driving returns. 

“A combination of monetary policy easing, maturity roll-off, and a crowded trade has weakened the appeal of these once-dominant instruments,” Stopford and Borbora-Sheen said.

“The tax efficiency that made gilts so compelling is now materially diminished,” Borbora-Sheen said. “With the Bank of England having cut rates by 125 basis points and the pool of attractive low-coupon gilts steadily shrinking, the yield advantage is fading and investors risk locking themselves out of more compelling income and capital gains from elsewhere."

The tax-equivalent yield for a one-year gilt – i.e. the pre-tax return needed from a fully taxable investment to match the post-tax return of a gilt – is steadily declining and has now fallen to around 6 per cent, compared with highs of about 8 per cent. “More investors have caught onto the tax trade, driving prices up and yields down,” Borbora-Sheen said. “At the same time, investors chasing what’s left are now having to take more duration risk – a clear shift from the original short-term, defensive rationale.”

Changing views
This erosion of gilt tax efficiency comes at a time when allocators are already reassessing portfolio resilience in the face of softening central bank policy and lower expected returns.

“We’re at a turning point. Twelve months ago, the trade was dominant,” Stopford said. “Today, it deserves re-evaluation – and may no longer be doing the job investors expect. When yield, diversification, and resilience are all considered, the balance is beginning to tilt elsewhere.”

While gilts may still have a role in balanced portfolios, Stopford and Borbora-Sheen said the alignment of factors that once made them a near-default choice for higher-rate taxpayers is no longer in place. They urge investors and their advisors to consider where future allocations may deliver stronger post-tax outcomes in a rapidly evolving market.

The firm also recently highlighted that UK equities have been overlooked and undervalued for over a decade, with the UK’s defensive market proving resilient. “Crucially, the UK market offers a powerful blend: high-quality, undervalued domestic firms alongside global leaders trading at discounts to international peers. This creates fertile ground for building diversified, value-rich portfolios,” Anna Farmbrough, UK quality portfolio manager at Ninety One, said.  Alec Cutler at Orbis Investments also recently highlighted the case for investing in UK firms, saying it is still an undervalued market. Cutler is heavily overweight in the UK market. See more commentary here.

Based in London and Cape Town, Ninety One is a global investment manager managing £139.7 billion ($189 billion) in assets.