Everything is crystal clear with hindsight

Are government bonds risky? This question arose a year ago, during a meeting with my bank. I wanted a low risk portfolio, but they noted that I did not want to hold UK government bonds. Whether it was the regulator who was insisting, or whether it was the way the bank was interpreting some Delphic pronouncement of the regulator, was not quite clear. But I could not be in both categories. Bonds were deemed low risk. So if I wanted to continue not to have bonds, my risk profile would have to change.

I did not doubt for a moment the financial probity of the British government. They were not about to default on the debt. But, at the time, long dated bonds yielded just under 2 per cent. At some point, the yield would rise, and I would be left with a capital loss. In the event, yields have recently risen, almost reaching 3 per cent on the 10 years. So a low risk portfolio would have landed me with a nice capital loss of some one third of the initial value of the portfolio. The outcome would have been very similar with US government bonds.

Looking around the world, a year ago there were many opportunities to incur large capital losses by buying government bonds. In Switzerland, the yield on 10 year bonds was just 0.60 per cent and is now, 1.10 per cent, implying a capital loss at present of almost 50 per cent. Even in Germany and its economic extensions of Austria and the Netherlands, rates have risen to give a loss of some 20 per cent on average.

Paradoxically, several economies where there has been genuine doubt about the financial stability of the government have generated very favourable outcomes for bondholders. In Portugal, yields have fallen from 8.6 per cent to 7.2 per cent, a nice capital gain of 20 per cent. In Spain, the increase in value has been one third. The stellar performer is Greece, where anyone willing to buy Greek bonds a year ago would have doubled his or her money.

Of course, all this is with the benefit of hindsight, when everything is clear. But why not? A paper recently published in Nature, one of the top two scientific journals in the world, claimed that a return of 320 per cent could have been made by trading the Dow Jones 2007-2012 using a strategy based on the number of times the word ‘debt’ appeared in the financial press. But both the rule and the trading strategy were all worked out after the event. It is perhaps not surprising that a return of 318 per cent could have been made if the words ‘colour’ or ‘restaurant’ had been used instead of debt.

Many regulators seem to inhabit this world of certainty, where everything can be known and someone is at fault if losses are made.  The real world is just not like this.  A year ago, I was lucky. Maybe I won’t be next time!

Paul Ormerod

As published in City Am on Wednesday 25th September 2013

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