What is Gilt Strip?

Full Definition

A gilt strip is created when a conventional UK government gilt is "stripped" -- separated, through the Bank of England's and Debt Management Office's official strips facility -- into its individual constituent cash flows, so that each of the gilt's coupon (interest) payments and its final principal repayment at maturity become separate, individually tradeable securities in their own right, known as strips (an acronym for "Separately Traded and Registered Interest and Principal Securities"). Because each strip represents a single, fixed cash payment due on a single future date with no interim coupons of its own, a strip is a form of zero-coupon bond: rather than paying periodic interest, it is bought at a discount to its face value, and the return to the investor comes entirely from the difference between the discounted purchase price and the fixed amount paid out on the strip's maturity date. Only gilts specifically designated as "strippable" by the Debt Management Office can be split into strips, and the process is reversible -- an investor or institution holding the complete matching set of strips derived from a particular gilt can reconstitute them back into the original conventional gilt if desired. Gilt strips are used by investors, particularly pension funds and other institutions, who want a cash flow with a precisely known amount payable on a precisely known future date, useful for matching a specific known future liability (for example, a pension scheme wanting to guarantee it can meet a particular tranche of pension payments due in exactly fifteen years' time) more precisely than a conventional coupon-paying gilt, whose regular interest payments would need to be separately reinvested at uncertain future rates to achieve the same result. For UK tax purposes, gilt strips are treated broadly as "deeply discounted securities" and the return an investor makes -- the difference between the discounted purchase price and the amount received at maturity or on sale -- is generally taxed as income (not capital gain) under Income Tax rules for deeply discounted securities, in contrast to a conventional gilt, where the periodic coupon is taxed as income but any capital gain from a rising gilt price on disposal is exempt from Capital Gains Tax; this distinction matters because it means gilt strips are typically less tax-efficient than conventional gilts for a UK investor holding them outside an ISA or pension wrapper, since effectively their entire return is taxed as income rather than benefiting from any CGT exemption. Because of this specialist tax treatment and the precision they are designed to offer, gilt strips are used mainly by institutional investors and specialist bond investors rather than being a mainstream retail savings product, and most individual UK investors seeking gilt exposure are more likely to hold conventional gilts or gilt funds instead.

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