Bonds for the Defensive Investor

Graham was a fan of US Government bonds in his time, largely due to the miniscule risk of default. UK Government debt (known as gilts) apply to these principles and so make very safe and reliable investments, well suited to the needs of the defensive investor.

Holding a AAA credit rating at the time of writing, UK government debt, like US government debt in Grahams time is essentially free from risk of default.

A gilt is effectively a small packet of government debt. In return for lending the govenment money, the investor will be repaid the initial value (£1) of the bond at a certain date in the future, and recieve interest (coupon) payments.

Gilts are issued at a par value of £1, yet after this they are free to trade on an open market, so their prices vary above and below the £1 mark. If you were to buy gilts below the par value and hold them to maturity, you would make a profit

To give an example of how Gilts work, let us examine UK Gilt Treasury Stock 4.75% 7 september 2015, which is currently trading at 112.49 pence. If you were to purchase this gilt, you would interest of 4.75 pence per bond per year, and on 7 september 2015 you would recieve £1 per bond. The actual yield values are obtainable from the UK debt management office website- overall this example yields 2.16%.

The choice of Gilt largely depends upon the investors financial situation- e.g tax status and personal preference- short or long term maturities. For a comprehensive explanation the UK debt management office's website is brilliant.

Graham does not Limit the Defensive investor to government backed securities alone, High grade corporate bonds he also deemed suitable. However, the "high-grade" part is incredibly important, as junk bonds carry risk in levels too excessive or the defensive investor. Standard and Poors, Moodys and Fitch give credit ratings to the security of most large companies. Graham also taught investors to watch out for clauses such as "calls" which allowed the issuer to the pay back the debt ahead of time at only a small premium to par - he referred to these as "Heads I win, tails you lose" situations.