Ahead of the Autumn Statement yesterday, HM Treasury revealed that the outstanding £1.9bn of debt from 3.5% War Loan will be redeemed on 9 March 2015. It follows a decision in October to redeem the much smaller 4% Consolidated Loan, which was the first planned repayment of an undated gilt of this kind by government for 67 years.
The 3.5% War Loan was issued in 1932 under a nationwide conversion campaign led by the then chancellor Neville Chamberlain to reduce the costs of servicing the national debt. It was put out in exchange for the 5% War Loan 1929 to 1947, which had been issued in 1917 as part of the government’s effort to raise money to pay for the First World War.
It is the most widely held of any UK government bond with more than 120,000 holders, or 60 per cent of all holdings of government gilts, according to Treasury figures. It will now be refinanced with new bonds benefiting from very low interest rate environment.
FE Analytics shows that several funds have the bond in their top 10 holdings. These include Ian Spreadbury’s £3.2bn Fidelity MoneyBuilder Income and £1.5bn Fidelity Strategic Bond funds and Mike Riddell’s £712.2m M&G Gilt & Fixed Interest Income portfolio.
Spreadbury, who also holds a smaller position in the bond in his £453.8m Fidelity Extra Income fund, says redeeming the loan is “clearly good news” for holders and adds that he has been a happy owner for some time because of two reasons.
“Firstly, the bond has generated attractive income compared to much lower yielding long maturity gilts. And secondly, there has also been the potential for price appreciation if the government called the instrument, as the bond has been trading below par. Obviously, we are pleased with how this has played out,” the FE Alpha Manager said.
“It had been something of a double-edged sword for the government – if yields drop further from here they could have refinanced it at a much lower level, so they’re giving up that option. But with yields close to all time lows, I suppose it is important for them to lock in the benefit now.”
Spreadbury (pictured) adds that the biggest challenge for War Loan holders is how to invest the proceeds. He has recycled them back into long-dated gilts, but notes that to achieve a yield equivalent to War Loan before the announcement investors have to look at single-A rated corporate bonds.
“Fortunately, there are opportunities to switch into bonds in that area still offering an attractive yield for the small amount of credit risk. But I caution investors not to extend risk too far down the credit spectrum in their search for yield at this point in the credit cycle,” he said.
Riddell points out that he and other bond managers at M&G had been urging the government to call in the 3.5% War Loan for a number of years.
The manager argues that the decision makes “a lot of economic sense” but adds that the “political rhetoric” around this and the calling-in of the 4% Consolidated Loan - such as that the repayment significantly improves public finances and the economic future - makes less sense.
“The stark reality is that the effect on the UK’s finances is negligible – depending upon where the gilts that refinance these bonds are issued, the decision in October to call the 4% Consol will be a saving to the taxpayer of between £2m and £3m per year, while calling the 3.5% War Loan will save around £15m per year,” he said.
“It’s still worth doing, but to put these numbers in context, the UK’s budget deficit this year is likely to be a bit above £90bn. Refinancing these perpetual gilts will trim the deficit by less than 0.02 per cent.”
Riddell (pictured) also takes issues with the strength of the wording in the Treasury’s announcement yesterday, even though it was toned down from the rhetoric of the 4% Consolidated Loan statement, which claims the low interest rate environment is a sign of the market’s confidence in the government’s fiscal plans.
“Government bond yields have hit record lows around the world – this is a global phenomenon, not a UK one,” the manager said.
“If bond yields were a measure of economic strength, then why are Spain’s 10 year bond yields lower than the UK’s? Why did almost every country in the eurozone see record low bond yields earlier this week (Greece is the major exception)? And why does Japan, one of the most indebted countries in the world, currently have 10-year bond yields at just 0.44 per cent?”
Peter Smart, head of group fixed income portfolio management at Brewin Dolphin, notes that the bond’s origins can be traced back to the 1700s, with direct links to debt issued by Gladstone in 1853 to consolidate obligations arising from the crash of the South Sea Company crisis of 1720.
“Like the passing of 100 years since the outbreak of the First World War, it is only fitting that this piece of ‘debt history’ should be retired.”
“Financial historians have thought the rescheduling of the coupons since issue have been tantamount to an act of default, but the fact of the matter is clear in that coupons, despite being lowered, have always been paid,” he said.
“The life of this piece of debt has witnessed the most momentous and tumultuous events the world has ever known and its retirement may act as a marker to the end of an era.”
“Perhaps, given the foggy outlook on the investment landscape, it may even mark the beginning of a bond market reversal.”
