It’s that time of the year again, and Bond Vigilantes has published BoA’s chart of the best and worst bond performers in 2011. I’m not going to read the results in reverse order, but none of the few remaining non-bank holders of Italian government debt will need Latin to know about their annus horribilis. The conventional bonds are off 8%, while the corresponding index-linkers have done even worse, posting a 14% total return loss.
The most bizarre feature of the table reflects the topsy-turvy world we’re in: UK index-linked debt comes top of the class, with an inflation-beating 16% gain. This stuff is designed to protect holders from inflation, that cancer which erodes the value of conventional bonds. Yet what’s this? Conventional UK gilts have done almost as well, returning just under 15%.
The conventionals have been helped by a single enthusiastic purchaser who hardly minds the price, in the shape of the Bank of England with its QE (the linkers have been left alone) so that today almost the only holders of long-dated conventional gilts are pension funds whose actuaries won’t left them sell. Indeed, as the yields fall, they demand that the funds buy more. Nevertheless, it’s a whacky outcome which surely won’t be repeated.
Lending to the UK government for 20 years now earns a miserable pre-tax return of 3%. We’re constantly told that gilts are a safe haven, despite the horrible projections for the Budget deficit, and that liquidity in UK debt never dries up. Well, maybe. Governments around the world are printing money at an accelerating rate. It would not take much of a change in sentiment for all those sitting complacently on cash and “liquidity” to decide they’d better get some real assets in exchange for government IOUs. The exit could suddenly get very crowded indeed.