A gilt-edged bond is simply a high-grade type of debt. What blue-chip stocks are to ordinary equities, gilt-edged bonds are to regular bond issues. As with any bond, the federal or corporate issuer is borrowing money from investors at a set rate of interest for a specific period of time.
The Basics of Gilt-Edged Bonds
The term "gilt" is of British origin, and gilt-edged originally referred to debt securities issued by the Bank of England, which issued the first ones in 1694. The bonds were printed on certificates with a gilded edge—hence the name. Along with Bank of England issues, debt issued by governments of the United Kingdom and the British Commonwealth (such as India, South Africa, and Northern Ireland) also became known as gilt-edged bonds. The term "gilts," which dates to the 19th century, arose as a nickname for British government bonds and remains current-day investors' shorthand for them.
However, the term "gilt-edged bonds" evolved and became a generic phrase for high-quality debt in general. It now describes global bonds issued by companies or governments that have demonstrated long-term financial stability—specifically, the ability to generate strong earnings, avoid default and consistently pay bondholders on schedule—a synonym for superior investment-grade debt.
"Investment grade" refers to the ratings assigned to the debt by major independent credit rating services like Moody's and Standard & Poor's. These firms research the financial health of bond issuers, including issuers of municipal bonds, and assign ratings to the bonds being offered. A bond rating helps investors assess credit quality in comparison to other bonds. For a bond to be categorized as "gilt-edged" on Standard & Poor's rating scale, for example, it must fall into one of the top four rating classes—AAA, AA, A, or BBB—preferably the first two classes. Ratings of BB, B, CCC, CC, C or D would be considered more speculative and, in the case of the "D" level, in default.
Gilt-Edged Bonds vs. Regular Bonds
"Regular bond" is a very generic term used to describe bonds that are corporate, municipal, high-yield, mortgage, private issue, and government in nature. Bonds in this category can include high-grade bonds, such as gilt-edged, but also the more speculative, and riskier, bonds that fall below investment-grade.
A gilt-edged bond is considered the next safest to a U.S. Treasury bond. Of course, this safety comes with a price: The low risk translates to low return. Often a gilt-edged bond is offering a yield that is well below the yields offered by comparable-term but more speculative bonds. For example, on Jan. 23, 2019, the U.K 10-year bond—one of the literal gilts—with a coupon (interest rate) of 4.25% was yielding 1.2%. In contrast, 10-year triple-C-rated bonds (the lowest rating a corporate bond can get) were averaging a 12% interest rate and a 5.13% yield on the same date.
As such, gilt-edged bonds would be best suited to a portion of a portfolio earmarked for capital preservation, or for investors seeking a steady if modest, income stream. More aggressive investors able to undertake risk and seeking greater returns would be better suited to lower-rated debt instruments.