Outspoken hedge-fund manager Hugh Hendry of Eclectica has been out propagating his theories on the bond market again. His latest master trade is buying up perpetual bonds issued by the UK Debt management office in 1917 to fund the First World War aka the ‘war bond’.
From Bloomberg.
(Bloomberg) — Hugh Hendry, who oversees about $500 million as co-founder of Eclectica Asset Management in London, said he’s buying World War I debt on the bet the U.K. is due for its worst round of deflation since the Great Depression. The gilts, known as perpetuals because they have no maturity date, have a coupon of 3.5 percent compared with the U.K.’s 4.5 percent inflation rate. Investors hold about 1.9 billion pounds ($2.9 billion) of the securities that still pay interest 90 years after the end of the Great War, according to the U.K.’s Debt Management Office.
From the DMO:
There are currently eight undated gilts in issue. These are the oldest remaining gilts in issue, some dating back to the nineteenth century. The redemption of these bonds is at the discretion of the Government, but because of their age, they all have low coupons and so there is little current incentive for the Government to redeem them. Most undated gilts pay interest twice a year; however some pay interest four times a year.
Specifically the war bond, issued in 1917, yields 3.5 per cent interest, with two payments – one in June and and one in December. There is some £1.9bn in issue. But there are other unconventional bonds too, among them “rump gilts” (of which six are undated). These can no longer be bought however. Redemptions are also subject to certain conditions being met. That being the government can call them in, but has to give a specific notice period. As their coupons were valued between 2.5 – 4 per cent, there was little incentive for the government to do so when traditional gilts were offering much higher coupons. Arguably that incentive to call them in is now there, however.
Certainly, if deflation is a concern, undated bonds do seem a good idea. As Marc Ostwald, senior strategist at Monument Securities, explains to FT Alphaville, if you’re looking for maximum price performance as the yield curve shifts lower across the board as rates continue to get slashed, undated bonds (also known as irredeemables) can have the highest price volatility:
It is a deflation hedge in so far as the fall in n ominal yields is being driven by expectations of CPI turning negative, and remaining there. That we will have a period of disinflation looks to be indisputable, but the risk given the vicarious way and the breakneck speed at which money is being printed, especially in the UK and USA is monetary authorities fail to withdraw liquidity quickly enough, as and when the cycle turns, and around the next corner of that road may well lie hyperinflation.
In the end, it all depends on your inflationary view. Given that undated bonds will hardly be the most liquid, if inflation suddenly starts to kick-in and do so quickly the risk of being stuck with them or selling them on unfavourable terms is high.
Hugh Hendry’s view? He tells Bloomberg that while he believes inflation will be back, investors should forget about the next 12 years, it’s the next 12 months that matter. Gilt-Edged market maker (GEMM) closing reference prices for all irredeemables are published here by the DMO every day.
Lets not forget, though, traditional issuance in 2009 will be high. But even though the DMO plans to issue substantial sums of short-dated 2-year gilts at 3.5 per cent, and 10-year maturities at 4.5 per cent, those terms are currently trading 1.91 per cent and 3.59 per cent respectively.
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