"You can’t be forced out further on the yield curve than a perpetual.”

You just never know what you're going to read these days. From Bloomberg:

"By Tom Cahill

Dec. 1 (Bloomberg) -- Hugh Hendry, who oversees about $500 million as co-founder of Ecletica 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.

“If you have a deflationary shock, the only instrument that will perform will be government debt,” said Hendry, 39, whose Eclectica Fund returned 38 percent this year, putting it in the top 1 percent of 1,817 funds tracked by Bloomberg. “Inflation is going to be back some day. But forget the next 12 years; it’s the next 12 months that matter.”

Here's a bit on Hendry:

"I antagonise people,' says Hugh Hendry. 'It's part of my skill set.' This single-minded attitude has helped Hendry to develop a successful contrarian investment style. His Odey Continental European fund had an impressive run towards the end of 2002, he decided equities generally 'were just not working' and cut the fund's equity exposure from 100% to 50% with 35% in bonds and 10% in non-European gold stocks. His career got off to a difficult start when he joined Baillie Gifford in 1990 as one of the firm's first non-Oxbridge educated recruits. After four years on the US desk, he fell out with his superior, a Baillie Gifford partner. After a short stint at Credit Suisse, his idiosyncratic talent was spotted by Odey founder Crispin Odey. He spent six years with the group before moving to his current home of Eclectica Asset Management, where he now heads up their European and agriculture mandates."

I bet you guessed that his first quote is going up on my blog somewhere.

Here's a bit on Gilts or Perpetuals:

"Undated gilts

There exist eight undated gilts, which make up a very small amount of the UK government’s domestic debt. These are perpetual bonds. These gilts are very old: some date from the eighteenth century, such as Consols. The largest, War Loan, was issued in the early 20th century. The redemption of these bonds remains at the discretion of the UK government, but because of their age, they all have low coupons, and there is therefore currently little incentive for the government to redeem them. However at the time of writing, the yield on these gilts is higher than the redemption yield on long-dated redeemable gilts, which implies that the market may be pricing in the chance that the government may redeem these gilts at some point. Because the outstanding amounts are relatively very small, there is a very limited market in these gilts."

I agree with him about inflation, but deflation I can't yet credit.

"The Bank of England lowered its benchmark interest rate by 150 basis points last month, its biggest move in 16 years, as the credit crisis pushes the country’s economy into recession. Governor Mervyn King told lawmakers last week that failure to get banks lending again could raise the risk of deflation. As interest rates drop and investors shun risk, even government debt with a low coupon will rise in value, Hendry said.

The five-year breakeven rate, a gauge of inflation expectations as measured by the difference in yield between regular bonds and index-linked debt, has been negative for more than month, suggesting investors are betting a recession will lead to deflation. The gauge fell to minus 102 basis points today; it was at positive 105 basis points at the start of last month."

Shun risk? There exiling it!

"‘Jolly Long Bond’

The “Jolly Long Bond,” as Hendry calls the war loan, will be the most reactive to deflation because not having a maturity means it has long duration, said Charles Diebel, head of European interest-rate strategy at Nomura International Plc in London. A bond with a higher duration will increase more in value than one with a shorter duration for a given decline in yield."

Can you have a higher duration than perpetual?

“His philosophy behind it makes a lot of sense,” Diebel said. “If you have an extended period of time where inflation is not a problem, you get no yield at the front end of the curve and people will be forced out the yield curve. You can’t be forced out further on the yield curve than a perpetual.”

Try me? I love that quote: "You can’t be forced out further on the yield curve than a perpetual.” That's a keeper as well. Calling George Gamow.

"A yield curve is a chart of yields on bonds of a range of maturities. Longer-dated bonds typically yield more than shorter- dated notes to compensate investors for the risk of holding them over time. "

Holding them over time? They're timeless. They're worth their weight in gold. Of course, I suppose the B of E will still need to be around, or somebody else to redeem them. Maybe that's how you price them. You bet on the survivability of the B of E.

"The bonds trade so infrequently Hendry said he bought them for his personal account, rather than for the funds he manages.

“You’d become a bit of a hostage” by holding too much of a rarely traded bond like the perpetual, he said. “Managing a hedge fund means reserving the right to change your mind all the time.”

Maybe he bought them for the hell of it, and decided to get some publicity for doing so. Also, it must be nice to hold perpetual bonds. I'd like to buy some. When people ask me why I bought them, I'll tell them that I plan to be around for a long time.

"The biggest risk to the investment is inflation, which Hendry said ultimately will return because of the actions policymakers are taking today to thaw credit markets. "

I agree with him.

"The U.K. government sold the perpetual in 1917, as British forces deployed tanks at the Battle of Cambrai, to repay loans it had sold since the conflict started in 1914. It marketed the debt with advertisements playing on patriotic sentiment.

“If you cannot fight, you can help your country by investing all you can in 5 percent exchequer bonds,” the advertisements said, according to an account in “The Financiers and the Nation,” by Thomas Johnston. “Unlike the soldier, the investor runs no risk.”

The 1917 notes were first sold with a coupon of 5 percent, a rate Prime Minister Lloyd George regarded as “penal,” according to Johnston’s book, first published in 1934 and republished by Ossian Publishers Ltd. in 1994. Neville Chamberlain, then Chancellor of the Exchequer, cut the coupon payment to 3.5 percent in 1932, where it has remained ever since.

The U.K. is unlikely to call the debt or retire it early because it would have to buy the bonds back at par, Hendry added. The gilts trade at about 78 pence today.

“The vast majority of this is locked up with retail investors,” said Diebel. Were the government to call the loans “they would be taking it away from households, rather than banks,” he added."

I've got to have some.