Fifty- and even 100-year bonds are back and selling out as investors take on duration risk in search of yield. At a time when short bonds yield peanuts or even give back less than issue price, ultra-long bonds due when your grandchildren will be hitting middle age have come to market. These bonds offer a return above 10- and 30-year bonds and absolutely certain income for decades.
A trendsetter is Belgium’s 100-year private-placement bond issued in April through New York City-based Goldman Sachs Group Inc. and Tokyo-based Nomura Holdings Inc. This issue offers a 2.3% annual coupon, which beats Germany’s 10-year bund that was priced to yield 0.08% to maturity. Both issues are senior, euro- denominated debt. In April, France sold nine billion euros of debt with a 2066 maturity and a 1.75% coupon.
Previously, France had to pay 4% on 50-year bonds issued in 2010. Other European sovereigns have come to market with 30-year bonds, including countries with formerly doubtful credits. For example, on July 27, Spain’s government sold 50-year bonds worth three billion euro with a 3.45% annual coupon. For reference, the Spanish 10-year sovereign recently yielded 1.08%.
Pension funds are the top buyers of 50-year and 100-year bonds, to match terms to their liabilities. Reuters reports that eurozone sovereign bonds with terms of 20 years and longer issued in the first half of 2016 exceeded the average annual issuance in the previous two years. From the sovereign borrower’s point of view, getting money for what is likely to be less than the long-term rate of inflation is a bargain.
How and why investors pony up for these long issues reflects the bond market’s ultra-low yields for senior corporate debt and subzero yields for Japan’s, Switzerland’s and a few other European 10-year sovereigns. An investor seeking a bond for a trust to generate income for children and even grandchildren could buy one of these long sovereigns. The grandchildren could cash it in at maturity and get face value, regardless of what happened to the bond price between the purchase date and, say, 2066 for a 50-year bond.
Pension funds and life insurance companies can use the very long bonds to match liabilities, Chris Kresic, senior partner and head of fixed income for Jarislowsky Fraser Ltd. in Toronto, confirms. But, he adds, “The risk is that inflation will rise before maturity, forcing down the bonds’ prices. So, we would view the very long bonds as traders rather than long investment keepers.”
Long inflation-linked bonds, similar to Canada’s real-return bonds or U.S. inflation-protected treasuries, cover the inflation risk. In late July, the U.K. government issued £50 billion of 50-year bonds, mostly to institutions eager to buy assets that guard value by raising yield with increases in national price indices. The British gilts were priced with a negative real yield of minus 1.32%. If British inflation, now 0.4% year-over-year, should pick up, the nominal payout of the bonds would rise and reduce the nominal cost of the investment. And, even without positive real yield, the bonds are an insurance policy rather than just an investment with a return.
In a normal bond market with sustained with low inflation in a 3%-4% annual range, negative-pay 10-year bonds would not exist. But with central banks, especially the European Central Bank, wrenching down interest rates, governments have taken advantage of low rates by stretching average maturity from 10 years in 2014 to 15 years in 2015 and probably 25 years in 2016, according to a Goldman Sachs survey. The proportion of negative-yield bonds in the European sovereign market rose from almost nothing in mid-2014 to 8% as of July 2016.
Buying 50- and 100-year sovereign bonds is choosing duration risk over credit risk. Although inflation may rise and drive down the value of these bonds, that is not important, says Jack Ablin, executive vice president and chief investment officer with Chicago-based BMO Harris Bank NA.
“Any bond that is longer than 40 years is more like an annuity that does not pay anything at the end,” Ablin explains. “The present discounted value of the principal does not matter anymore. The long bond provides a known and certain cash flow for decades. But it is fixed. If you want cash flow to rise with inflation, you are better off with stock dividends.”
From a more technical point of view, 50- and 100-year bonds have uses, explains Edward Jong, vice president and head of fixed-income for TriDelta Investment Counsel Inc. in Toronto. “Say you have a $100-million portfolio with four years in average duration and you want to go to seven years average duration,” he says. “You could turn over the whole portfolio and buy bonds with seven years duration or you can just buy $4 million of 100-year bonds with 80 years duration and 4% coupons. That barbell would move the average duration up to seven years. Moreover, with a fairly flat yield curve, which is what we have now, you can get 80 basis points of extra total yield on the barbell bullet strategy [vs] the seven-year duration bullet strategy.”
But there is another risk: liquidity. If rates rise and bidders disappear, the lead investment dealer for a sovereign could be expected to come in with a bid, but it would be low. If the bonds in question were corporates, Jong warns, the dealer might back off entirely.
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