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Bond of the Week: 3 December 2008

Long dated Gilts, War Loan etc, surge higher................


This year, the majority of the action in the Gilt market has been in the shorter-dated end. Investors have flocked to the security of government-guaranteed debt to protect their capital, egged on by the prospect of even lower interest rates.

The impact on the shorter end of the curve* has been dramatic. The flood of money into 1 to 5 year maturity gilts has bid up prices, forcing down the yields on these fixed coupon securities. The benchmark 5.75% Dec 2009 issue, which has just one year to run to maturity, has gained over 4 points in price terms from its lows back in June, and now yields a less-than-generous 1.3% to maturity.

The longer dated end of the curve, however, has been somewhat of a Cinderella. Investors have preferred the security of shorter dated maturities, which ensure a relatively quick return of capital, rather than risk locking up their funds for ten years or more. There is also the nagging uncertainty of inflation coming back to haunt us in the future, which would severely impact longer dated bonds.

The last few days have seen longer dated Gilts start to play catch-up. Prices for 10 and 30 year US Treasuries and the 30yr German BUXL have soared, and well-known (and top performing) hedge fund manager Hugh Hendry has been widely quoted in the press stating that he is buying the undated 3.5% War Loan bond for his own personal portfolio.

We would be inclined to agree with Mr Hendry. A study of the chart of War Loan (see right) shows that this instrument displays clear range-trading characteristics. This year’s range has until recently been constrained between 71 and 80, but the last few days have seen the resistance taken out, opening the door for a potential rally up to the 2006 highs above 90.

At this morning’s mid price of 86.5, the running yield on War Loan can be calculated as 3.5%x100/86.5= 4.0%. This does not seem unreasonable given that base rates now stand at 3.5%, and are set to go lower.

Our view: Its time to buy long-dated Gilts. However we suspect that War Loan may not be the best vehicle. The bond is less liquid than conventional dated Gilts, and thus is more prone to being squeezed. This might well be a good thing for investors already holding the security, but for those who have yet to put on the trade, we would suggest the UK Gilt 4.25% June 2032 (see lower chart). This bond is trading a little over par this morning at around 101, offering an attractive yield to maturity of 4.2%. Should the current enthusiasm for long dated Gilts continue, the price also has further upside potential.

Mark Glowrey    

* The plot of the Gilt yields against maturity is known as the "yield curve". Typically this slopes upwards, with longer-dated issues yielding slightly more than shorter dated.     


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