4 Feb 2013

“The UK is a must to avoid. Its Gilts are resting on a bed of nitroglycerine.” So said Bill Gross in January 2010. Mr Gross (who works for Pimco) is the best known bond investor in the world. He is the only fixed interest specialist invited on to the Barron’s Roundtable. When he made that comment, 10 year Gilts yielded 4%. Eighteen months later their yield had fallen to 1.5%. As it turned out, Bill Gross was warning people away from a gilt-edged buying opportunity. To be fair, the stellar performance of gilts, as well as US Treasuries and German Bunds, required the normal rules of value to be suspended. The era of very low bank rates, negative in some cases in nominal as well as real (inflation adjusted) terms, accompanied by quantitative easing (the process by which central banks purchase long-term assets for cash)has resulted in investors and savers becoming increasingly desperate for yield. People who are desperate for yield will gradually accept both lower returns and higher risks. By any sensible standards, the UK state is rather high risk. While it is true that a sovereign government with its own currency will never actually go completely bankrupt (because, in popular terminology, it can print its own money – an option no longer open to e.g. Greece), uncontrolled borrowing will lead straight to devaluation and inflation. The main worry about investing in the UK is not default: it is getting stuck with an asset whose price falls painfully, leaving the choice of selling at a loss or continuing to hold paper that yields well below the prevailing levels of interest rates and, most damagingly, inflation. The history of the UK economy can be seen in the nominal yield of gilts and the price movements. The first gilt I ever bought was issued in April 1992. It had a nominal yield of 8.75% and a life of 25 years i.e. it will redeem at par (100) in 2017. It is hard now to imagine that the government would offer investors a guaranteed 8.75% for 25 years: that is because the equivalent offering today (there actually is a 4.75% 2038 gilt out there) yields 3.2%....