Understanding the Different Types of Bonds in the UK

Bonds are a core part of many investment portfolios, offering a relatively stable income stream and lower volatility compared to equities. In the UK, fixed interest bonds come in a range of forms, each with its own risk profile, return expectations, and market purpose. Whether you’re an individual investor, a pension fund manager, or simply curious about how government and companies raise money, understanding these instruments is essential.

What Is a Bond?

A bond is a type of debt security. When an investor buys a bond, they are essentially lending money to the issuer – be it the UK government, a local authority, or a corporation – for a fixed period. In return, the issuer agrees to pay regular interest (known as the ‘coupon’) and to return the principal at maturity.

The term fixed interest refers to the fact that most bonds pay a predetermined rate of interest at regular intervals – typically every six months. This fixed income is what differentiates these instruments from shares, where dividends may fluctuate or disappear entirely. While some bonds, such as index-linked gilts, adjust payments for inflation, most traditional bonds promise a fixed, predictable return.

Government Bonds: Gilts

The most well-known fixed interest securities in the UK are gilts, which are bonds issued by the UK government. Gilts are seen as low-risk because they are backed by the government’s ability to raise taxes and print money.

There are several types of gilts:

• Conventional Gilts: These pay a fixed coupon every six months and repay the face value at maturity.

• Index-Linked Gilts: These adjust both the capital and interest payments in line with the Retail Prices Index (RPI), protecting investors from inflation (UK Debt Management Office 2023).

Gilts are a staple in pension fund portfolios, particularly because of their perceived safety and predictability.

Corporate Bonds

Corporate bonds are issued by companies to raise capital. These come with a higher level of risk compared to gilts, as repayment depends on the company’s financial health. To compensate, they generally offer higher yields.

Corporate bonds are further divided by credit quality:

• Investment Grade Bonds: Issued by companies with strong credit ratings. These are considered relatively safe.

• High-Yield (Junk) Bonds: Issued by companies with lower credit ratings, offering higher returns but with greater default risk (Fitch Ratings 2022).

Municipal Bonds

In the UK, municipal bonds are less common than in countries like the United States, but they do exist. Local authorities can issue bonds through mechanisms like the UK Municipal Bonds Agency. These are typically used to fund infrastructure and community projects (UKMBA 2024).

Green Bonds

A more recent development is the green bond, designed to fund projects with environmental benefits. The UK government issued its first sovereign green bond in 2021, and companies are increasingly following suit. Green bonds must meet specific criteria to ensure transparency and genuine environmental impact (HM Treasury 2021).

Retail Bonds

Retail bonds are a type of corporate bond designed specifically for individual investors. They are typically listed on the London Stock Exchange’s ORB (Order Book for Retail Bonds) and have lower minimum investment thresholds.

Retail bonds offer an accessible way for private investors to gain fixed income exposure, although liquidity can be lower compared to larger institutional bonds (London Stock Exchange 2023).

Subordinated and Perpetual Bonds

Some bonds come with additional complexities:

• Subordinated Bonds: These sit lower in the capital structure, meaning they are paid after senior bonds if the issuer defaults.

• Perpetual Bonds: These have no maturity date and can go on indefinitely, although they often include call options allowing the issuer to repay early (Bank of England 2022).

These instruments are often used by banks and financial institutions and can be quite volatile.

Why Should Investors Own Bonds?

Bonds play a crucial role in a diversified investment portfolio for several reasons:

• Income Generation: Bonds provide regular interest payments, making them a popular choice for income-focused investors such as retirees.

• Capital Preservation: Government and investment-grade bonds offer relative safety, which can help protect capital during times of equity market volatility.

• Diversification: Bonds typically have a low or negative correlation with equities. When share prices fall, bonds often hold their value or rise, providing balance.

• Defined Returns: Unlike equities, most bonds come with a maturity date and a known yield, which can add predictability to financial planning.

• Inflation Hedging (in specific cases): Index-linked gilts help protect against the erosive effects of inflation, which can otherwise reduce the purchasing power of fixed returns.

• Behaviour Management: Perhaps one of the most underrated reasons to own bonds is psychological. When markets turn turbulent, holding lower-risk assets like bonds can make it easier for investors to stay calm and stick to their long-term plan, rather than panic-selling equities. In that sense, bonds can act as a behavioural anchor.

Whether used as a steady income source, a counterbalance to equity risk, or a defensive anchor in turbulent markets, bonds serve multiple strategic purposes.

Final Thoughts

Fixed interest bonds in the UK span a wide spectrum – from ultra-safe government gilts to riskier high-yield corporate debt. Each type plays a role in the broader financial ecosystem, helping to finance public services, infrastructure, and corporate expansion while offering income and diversification to investors. For those looking to build a balanced investment portfolio, understanding the nuances of these different bond types is a valuable step forward.

References

Bank of England. 2022. The Capital Structure of Banks. London: Bank of England. https://www.bankofengland.co.uk

Fitch Ratings. 2022. Corporate Bond Credit Ratings Explained. London: Fitch Ratings. https://www.fitchratings.com

HM Treasury. 2021. UK Government Green Financing Framework. London: HM Treasury. https://www.gov.uk/government/publications/uk-government-green-financing-framework

London Stock Exchange. 2023. Order Book for Retail Bonds (ORB). London: London Stock Exchange. https://www.londonstockexchange.com

UK Debt Management Office. 2023. Gilts Market Explained. London: UK DMO. https://www.dmo.gov.uk

UK Municipal Bonds Agency (UKMBA). 2024. Local Authority Financing via Municipal Bonds. London: UKMBA. https://www.ukmba.org.uk