Money: Chasing the yield on War Loan and PIBS

War Loan is an unlikely star performer in the investment stakes, but last year this perennial investment dog had its day. Clifford German looks at the special features of irredeemable stocks.

Over the past 12 months the price of a pounds 100 unit of War Loan stock paying an annual interest of 3.5 per cent has risen from just under pounds 44 to pounds 57.75, so investors who bought the stock last January will have made a capital gain of 30 per cent plus an income of 8 per cent gross, making it a better investment than the average share in the index of the top 100 UK companies.

Over the years, however, War Loan is a monument to the poor investment value of government stocks. Gilt-edged they may be, but government stocks paying fixed rates of interest are vulnerable to inflation. All government stocks have a par value of pounds 100 and pay annual interest expressed as a percentage of their par value. But the value of that interest varies considerably relative to the rates of interest investors can get on other forms of savings, which is why the market price of gilts can fall well below par.

At one point in the Seventies, in order to meet its borrowing requirement the government had to offer up to 15.5 per cent a year interest on a new stock

The huge interest costs on high coupon stock explain why the government began issuing index-linked gilt edged stocks as an alternative to fixed rate stocks. When inflation was at its height, however, existing stocks paying as little as 3 per cent a year plunged to less than a third of their original issue price.

But at least investors know they will get back precisely 100p in the pound when their gilt edged stocks mature. War Loan (and a handful of other stocks, like 2.5 per cent Consols) is different because it has no fixed maturity date when the capital will be repaid, and as the years go by it looks less and less likely that it will ever be repaid.

War Loan dates back to the First World War, when patriotic investors bought the original stock with no thought of when they would get their money back. In fact, the original interest rate of 5 per cent was cut to 3.5 per cent in the Depression and has never been restored. Since 1919, inflation has cut the value of money to little more than 5p in the pound, so even after last year's leap in the price of the stock an original investor, if there were any left, would have lost 97 per cent of their capital.

Investors who buy it today are in effect buying an income stream of pounds 3.50 a year on each pounds 100 of nominal stock. At the current price of pounds 57.75 for pounds 100, nominal investors can still get pounds 173-worth of nominal stock and just over pounds 6 of income for an actual investment of pounds 100. But if they want their money back, they have to sell the stock for whatever it is worth. If interest rates fall firmly to 3.5 per cent or less, then War Loan will at least regain its par value, but it will still be a shadow of its capital value.

Investors who want to take a gamble on falling long-term interest rates might also consider PIBS (Permanent Interest-Bearing Shares), issued by several leading building societies, including Bradford & Bingley, Britannia, Coventry and Skipton. They too pay fixed rates of interest on stock which they will never redeem, but they pay better rates than War Loan. Coupons, prizes and minimum investments vary, but they all yield about 7.5 per cent a year and they qualify investors for membership if the society converts or is taken over. Buy and sell through a stockbroker, but watch out for commission charges.