What Is a Gilt-Edged Bond?
Strictly speaking, a gilt-edged bond is a debt security issued by the Bank of England at a fixed interest rate and maturity. The term is often used informally to describe any bond that has a very low risk of default and a correspondingly low rate of return.
The Basics of Gilt-Edged Bonds
The term gilt-edged bond was originally meant literally. Bonds issued by the Bank of England on behalf of the British Crown were printed on paper that had a gilt or gilded edge. To this day, the short-hand term "gilts" is used only to refer to these British government bonds.
However, "gilt-edged" has come to be used to describe bonds that are investment grade. That is, they have a very low risk of default and a relatively modest rate of return for investors. They are seen as safe haven investments.
Bonds described as gilt-edged today may be issued by financially stable governments and mature blue-chip companies. The government or company issuing the bonds is borrowing money from investors at a set rate of interest for a specific period of time.
A bond described as gilt-edged should have one of the top ratings assigned by credit rating services such as Standard & Poor's and Moody's.
Because of their low risk, gilt-edged bonds offer yields that are well below the yields offered by more speculative bonds. Such bonds often serve as the cornerstone of investment portfolios for conservative investors whose top priority is capital preservation.
How "Gilt-Edged" Is It?
Even the bluest of blue-chip companies can run into trouble. A study by the National Bureau of Economic Research notes that 36% of the entire corporate bond market defaulted during the railroad crisis of 1873-1875.
Municipal government bonds, however, generally are closer to meriting the gilt-edged designation. A report by Moody’s Investors Service indicates that there were just four Moody’s-rated municipal defaults in all of 2016, all of them related to the financially-troubled U.S. Commonwealth of Puerto Rico.
Municipal defaults and bankruptcies became more common in the decade ending in 2016 but were still rare, according to the Moody’s report. The five-year municipal default rate since 2007 was 0.15%, compared to 0.07% for the entire study period of 1970-2016. Those figures include all bonds rated by Moody’s, not just the highly-rated issues.
In comparison, the global corporate default rate was 6.92%. Competitive enterprises such as housing and healthcare had the highest default rates.
Thus, the term gilt-edged may imply safety, but an interested investor should always check the rating before buying.