ALEX BRUMMER COMMENT: Cash is the new prudence

By ALEX BRUMMER, CITY EDITOR
Updated:

Tim Breedon must be feeling the heat. As the chief executive of Britain's biggest long investor in the stock market, the group's fund managers make a habit of attacking under-performing bosses elsewhere.

Now it is Legal & General's turn. Presiding over the group's first dividend cut in living memory is hardly going to endear Breedon to investors. But at present he is placing prudence and preservation of capital first.

Still there is plenty more to worry about. Whereas competitors such as the Prudential have built up surpluses during the bad times, L&G's has shrunk from a handsome £4.1billion at the end of 2007 to £1.8billion now.

It also appears that the insurer may have been over-exposed to the wrong kind of corporate bond. It has had to increase the provisioning on annuities by £650million to £1.2billion. It is no defence to simply blame all of this 'on the worst default levels since the Great Depression'.

Legal & General

Grim news: Legal & General has announced its first dividend cut

L&G also seems to have made the most common error among private investors. It stampeded out of shares in 2008 and in the first quarter of 2009 and turned them into cash.

While this might seem like a safety-first policy it finds itself holding record levels of cash in a period when interest rates are zero bound and returns are negligible.

A bit more foresight might have seen it heading into cash much earlier after the credit crunch emerged in 2007. The insurer is now firmly on the defensive and determined to see off the short-sellers.

But what took it so long?

Debt doubts

Any complacency in Whitehall about the ability of the Government to fund its soaring borrowing needs must be rapidly vanishing after the first failure of an auction of giltedged stocks since 2002. Indeed, if index-linked bonds are placed to one side you have to go back to 1995 to identify such a failure.

The embarrassment of failing to fully cover the sale of £1.75billion of 40-year gilts cannot simply be brushed aside as a market blip. It can be no coincidence that it came immediately in the wake of Mervyn King's searing warning against a second UK fiscal package.

Labour's borrowing needs are escalating exponentially. At the time of the Pre-Budget Report in November it was estimated that the Government would have to raise a stonking £147.9billion in the 2009-10 fiscal year.

This sum now looks hopelessly out of date. The slump in tax revenues, the uptick in public spending and the bail-out of the financial system means that the borrowing target will have to be raised substantiallyin next month's budget. There is also some confusion in the bond markets about the Bank of England's intentions.

It has gleefully been buying shorter- dated gilts as part of its effort to refloat the economy. However, there are hints from King that the Bank may yet decide to defer some of its £75billion buyback programme.

Market operators are saying that by keeping its buyback plans close to its chest the Bank is adding a new element of uncertainty to the gilts auctions.

It is not entirely easy for anyone outside the esoteric world of bonds to understand how it is possible for one arm of government - the Debt Management Office - to freely offer new government bonds for sale while another branch of government - the Bank of England - is greedily buying them up.

Essentially, the Bank is changing the maturity profile of government debt by exchanging dated stocks for cash.

There is a further complication. Another of Gordon Brown's financial reforms was to take gilt operations away from the Bank and give it to a separate organisation.

Yet there is no institution better equipped to understand forces in the gilts market, from overseas investment flows to the needs of the banking system, than the Bank.

It is hard to believe that if debt management had been in the hands of the governor, rather than a freestanding agency, that an auction of long bonds would be launched less than 24-hours after King had warned on the public finances.

As Government cash needs escalate, the decision to hive off debt management will be seen to have been as cackhanded as the defenestration of the Old Lady's role in regulation of banking.

Grocery King

With the help of stalwart family shareholders, grocer J Sainsbury escaped the clutch of a leveraged buyout attempt at the peak of the credit bubble.

Although the shares may be worth just half what they were then, long-term investors ( including this writer) can at least draw comfort from Justin King's shrewd management which has kept samestore sales bounding along.

Use of its upmarket-quality reputation to back strong own-brand sales is a neat trick to pull off.

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