Changing Picture

For most of the past two years, UK government bonds looked like they were finding their footing. Yields had retreated from the January 2025 spike, inflation appeared to be easing, and markets were pricing in two Bank of England rate cuts for 2026. For investors who had endured the volatility of the post-pandemic period, gilts were once again looking like a reliable destination. In this week's blog, we consider that the picture has changed dramatically in the past three weeks.

At the point of writing, the UK government borrowing costs have surged to their highest level since the 2008 financial crisis, with the benchmark 10-year gilt crossing 5% as investors scrambled to price in rising inflation risks and a growing probability of interest rate hikes. Yields on the 10-year gilt have jumped around 68 basis points in the 15 trading days since the US-Iran war began, while the yield on the 2-year gilt has added around 97 basis points. The rate cut that markets had considered a near-certainty for March has been shelved. The question now is not when rates fall next, but whether they might need to rise, which was unthinkable a mere month ago. For investors sitting in or considering gilts, this is not comfortable reading. And it raises a question that was already worth asking before this latest shock: is the assumed safety of government bonds actually safe at all, and what are the alternatives?

The Iran conflict was the immediate trigger, but the vulnerabilities it has exposed in the gilt market are structural, not situational. The repricing of UK sovereign debt reflects broader dynamics: elevated gilt yields influence mortgage rates, corporate borrowing costs, and investment decisions across the economy, and the episode underscores the sensitivity of sovereign debt markets to geopolitical development. Sadly, the UK entered this crisis in a particularly exposed position. Even before the conflict, the UK had the highest government borrowing costs of any G7 nation, with long-term 20 and 30-year gilts already trading above the 5% threshold. The government's fiscal headroom, the buffer Rachel Reeves had carefully constructed against her own fiscal rules, has been eroding in real time. Bloomberg economists calculated that market moves since the conflict began have already erased around £3 billion of the Chancellor's fiscal cushion, out of a total headroom of £23.6 billion estimated by the OBR at the start of March.

The deeper issue is that the UK's public finances offer limited room for error. The government's borrowing plans include £138 billion in 2025/26, with meaningful fiscal consolidation not expected until 2029-30. This backloaded approach risks eroding market confidence, particularly given persistent risks from climate-related costs, pension system pressures, and weak economic growth. Gilt investors are therefore not simply taking a view on short-term interest rates. They are taking a view on UK fiscal credibility over a decade or more, in a global environment that has just become significantly more volatile.

There is an argument that higher gilt yields are simply an opportunity, more income for less price. And it is not entirely wrong. From an investment perspective, higher yields are starting to restore value in parts of the curve. However, the corollary is equally true: investors who bought gilts in early 2026 on expectations of rate cuts and falling yields have already suffered meaningful capital losses. Bond prices and yields move in opposite directions, and the move in the short end alone, nearly 100 basis points in a matter of weeks, has been painful. The 2022 gilt crisis offered a vivid illustration of how quickly that dynamic can turn severe. Triggered by a single ill-judged budget statement, it required the Bank of England's active intervention to prevent a cascade of forced selling by pension funds. While regulatory changes since then have increased resilience, the underlying vulnerability, a sovereign bond market dependent on market confidence in fiscal sustainability, remains. Volatility is, in essence, the price of owning gilts. When that volatility is driven by factors entirely outside an investor's control, a geopolitical shock, a fiscal misstep, a shift in global capital flows, the question of whether the yield justifies the risk becomes genuinely live.

Against this backdrop, the characteristics of direct lending to property developers look considerably more attractive than they might in calmer markets. At Invest&Fund, investors earn a fixed return over a defined term, secured against a first charge on UK residential property. The return is not a function of market sentiment, interest rate expectations, or sovereign creditworthiness. It is a contractual entitlement, backed by a tangible asset. The distinction matters. When gilt yields move 68 basis points in three weeks, existing holders suffer a capital loss. When a property development loan performs as contracted, investors receive precisely what they were promised. The two products inhabit different risk universes, and it is worth noting that direct lending carries its own risks, including borrower default and property-market exposure. But the risk profile is fundamentally different: it is project-specific and asset-backed, rather than macro-dependent and mark-to-market.

For investors who have found themselves sitting in gilts partly by default, attracted by the familiarity of government bonds rather than by active conviction, the current environment is a reasonable moment to examine whether that allocation is genuinely working. A 10-year gilt yielding just over 5% in an environment where UK inflation is expected to breach 5% this year means a real return close to zero, with meaningful capital risk on the downside if yields move higher still. Against that, a fixed, asset-backed return from direct lending held in an IFISA wrapper that shelters all income from tax looks like a different proposition entirely.

One of the least-discussed virtues of direct lending as an asset class is its relative imperviousness to the kind of market noise that has dominated headlines in recent weeks. The value of an Invest&Fund loan is not updated on a Bloomberg terminal every second. It does not respond to geopolitical events in the Strait of Hormuz, or to a speech by the Chancellor, or to revised OBR growth forecasts. It responds to one thing: whether the underlying development project is progressing and whether the borrower is performing.

That simplicity is not naivety; rigorous due diligence, conservative loan-to-value ratios, and first-charge security are the foundations of the asset class. But it does mean that investors can assess their position in terms they can understand and control, rather than watching a yield curve driven by events in the Middle East. Let's pepper these statements with some honesty, nobody is suggesting that gilts have no place in a portfolio, or that the current crisis will necessarily deepen. Some fund managers argue that if oil prices stabilise, bond yields could fall back and the Bank of England may be able to look through the inflationary spike. That may prove correct, but the volatility of the past three weeks is itself the argument.

In an environment of elevated geopolitical risk, precarious public finances, and genuine uncertainty about the future path of inflation and rates, the case for holding at least a portion of a fixed-income allocation in something genuinely uncorrelated, something asset-backed, contractual, and tax-sheltered, is worth making seriously.

That is exactly what Invest&Fund offers.

Invest & Fund has returned over £370 million of capital and interest to lenders with zero losses, showing the rigour that governs our business. To take maximum advantage of this robust and exciting asset class, please visit www.investandfund.com

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