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The Actuary The magazine of the Institute & Faculty of Actuaries
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Book review: The Golden Age of Government Bond Analysis (1961-1986)

I was absolutely delighted to be asked to review this publication on two grounds; firstly, I knew all the authors well – they were all highly respected partners of the major gilt-edged brokers and I spoke to them on a daily basis as they provided advice (based on the analyses set out) on management of Clerical Medical’s gilt-edged portfolio. Secondly, I know that their analyses worked! It has always bothered me that actuarial judgements are taken over such a long time period that is it is almost impossible to tell whether the judgement was correct or not.

In contrast, the gilt-edged market is a magnificent laboratory to test the validity of any hypothesis and over any reasonable timescale. Security was, and, I hope, still is absolute, marketability is exceptionally good and the costs of dealing have always been low. In the period covered by the authors, stockbrokers and stockjobbers were kept entirely separate and so there was no conflict of interest between the broker and his client. Against this background Clerical Medical made money (for example, performed better than an average portfolio of gilt-edged securities) in 9 out of 10 years between 1967 and 1977, which I think is a fair test of the work done by the authors.

There were three reasons that we and, I would have to admit, a number of our major competitors, made money on a consistent basis. In the first place, there was a high public sector borrowing requirement over the period. This meant that the Government was forced to sell a large quantity of gilt-edged securities throughout and, as anyone can tell you, particularly in today’s very difficult economic climate, a forced seller does not do well (and often does very badly).

The Government’s chosen method of raising finance was through ’tap stocks’; these were usually new tranches of stock, which were issued on a cheap-enough basis to tempt buyers in. It was the job of the authors to gauge when that point had been reached (and they were pretty good at it!). Incidentally, it seems inevitable that we are about to enter a very similar, or even more exaggerated, scenario over the next five years or more and I hope that today’s brokers and fund managers take similar advantage.

Another major advantage from managing a gilt-edged portfolio actively over this period was taxation. The taxation rules affecting both income and capital gains were complicated, but allowed both gross and net funds, but particularly the latter, to save very significant amounts of tax.

The most important and interesting way of making money was from making decisions based on the authors’ analysis, set out in their publication. Profitable switches between two different gilt-edged stocks could be made by identifying anomalies, or by taking advantage of kinks in the yield curve, or by taking a view on the direction of interest rates (and the authors specialised in all three areas). It is hard now to explain the paucity of information which was then available. Throughout the 1970s the only live information that we received was a closed circuit non-speaking television from Greenwell, which updated prices three times a day and also printed out major announcements - such as trade figures. We had two direct telephone lines (it was amazingly difficult to get a nationalised BT to install these, or to keep them working!) to Bryce Cottrell at Phillips and Drew and to Gordon Pepper and Mike Higgins at Greenwell. These brokers would also, using the desperately limited computer power at their disposal, produce yield curves and other statistics. These in turn would throw up anomalies in the marketplace, which would form the basis of our transactions.

I knew three of the authors particularly well. Bryce Cottrell (who sadly died some two years ago) was probably the best and most practical pure mathematician that I ever knew. He loved the mathematical certainties of the gilt-edged market and his judgement on anomaly switching was second to none. I may be wrong, but he always seemed to me to be more interested in this side of the market, which was relatively certain, than in the direction of interest rates, where we can all get it wrong.

Pat Phillips was the most computer literate of the three. He was fascinated at a very early stage in the potential of computers to aid investment management, and used this throughout his career to the advantage of both his firm and his clients. He was also the author of the first really definitive book on the gilt market, published in 1994 and twice subsequently revised.

Gordon Pepper had two unique and invaluable traits; he was a genuinely original thinker – I promise you that he was the originator of most to the analyses set out in these papers – but his thinking was on a wider basis. He certainly was the first gilt broker to understand the importance of monetary economics and this was of enormous importance to the direction of interest rates in the 1970s when inflation became such a problem. He also has the gift of making very complicated issues appear simple. Some of you may, like me find Robert Clarkson’s brilliant mathematical proof of the ’rope ladder’ to be quite hard going, but it was Gordon who could bring it down to simple but basic principles which even I could understand.

Finally, it is good to know that at least two of the authors are still, in their 70s, actively engaged on thinking about gilts. I spoke to Pat and to Gordon in December. Pat had just produced a new gilt-edged website which he shared with me and which does quite amazing things (I’m sure he would love to explain them to you if you contacted him direct). Gordon is working with Tim Congdon and others on the current economic outlook. When I rang him, he was about to go to see the Shadow Chancellor to explain to him that the Bank of England was restricting the growth of the money supply so much that they would cause the recession to become much worse. I have no idea whether he is right, but isn’t it great that he cares!

Seriously, I would advise anyone interested in mathematics and economic history to read these papers. They are accurate, well written and some of the material will make you money today.

Robert Walther