Mystery bond buyers are raising eyebrows in European markets by lending millions of euros to governments for the next 100 years.
First to bite was Ireland, a country hard hit by the euro zone debt crisis and forced into an international bailout just six years ago. At the end of March, the Irish debt management agency announced it had privately raised €100 million through a 100-year bond at a yield of 2.35 per cent, a rate lower than US 30-year debt. It was, said the agency, “a big vote of confidence in Ireland as a sovereign issuer”. One month later Belgium followed suit with a €100 million sale.
Centennial bonds are a rarity in debt markets, where 10-year bonds are the norm and 30-year debt is considered the standard long-term issue.
Only a handful of countries have ever entered the market, including Mexico and the Philippines. The sale of two bonds in quick succession has been hailed as proof that investors expect global inflation to stay in the doldrums for decades to come.
The sudden flourishing of century bonds appears to be led by investors, with both Belgium and Ireland's €100 million, 100-year bonds arranged by Goldman Sachs and Nomura at the request of investors, with some suspecting the buyer is a single European insurer.
Although investing in 50-year or 100-year debt entails taking a risk on what the economy of a country will look like decades in the future, investors with particular payment commitments can use longer maturities to better match their own liabilities.
Investors such as pension funds and insurers have a need to find positive returns in a sea of negative rates and have two options right now, says Fraser Lundie, co-head credit at Hermes Asset Management. "You add risk by going for either longer dated debt or poorer credit. Some investors are penalised by regulators for buying poorer credit so they are going for longer-term debt."
On the surface, 100-year bonds sound a better bet for borrowers than investors. When rates are low, governments want to cut the cost of funding a country’s debt for the longest possible timeframe, extending the average life of outstanding debt and staggering redemptions in the process.
“We are in a low-rate environment so taking advantage by issuing long-dated debt makes sense,” says Patrick Jacq, senior strategist at BNP Paribas.
“Note that it’s not just 100-year debt, there have also been a number of other popular long maturity bond sales recently. France and Belgium issuing 50-year bonds, Italy issued a 30-year one.”
These sales of ultra-long debt have attracted fierce demand, with Italy’s 2047 bond breaking records with an order book in excess of €25 billion, as economic data indicate that inflation and global growth are on track to remain low.
One risk for buyers of long-term debt is “duration” risk, a technical term to describe a bond’s sensitivity to changes in interest rates. Bonds with high duration experience the largest changes in prices when underlying interest rates alter. That means holders of such paper can outperform the broad bond market when interest rates fall, but also suffer the most in a climate of rising rates.
Longer-dated bonds offer an extended period of time in which interest rates can increase, eroding the value of the bond, but high coupon payments and yields can ameliorate the effects.
While century bonds issued by Brazilian company Petrobras in 2015 are exposed to years of possible interest rate moves in addition to the credit risk, the 8.45 per cent yield puts the duration risk at a level similar to that of UK gilts, says Alan Higgins at Coutts Private Bank.
“People see 100 years and shudder. Sometimes they don’t do the maths. The terminal redemption value in 100 years is almost irrelevant. That creates opportunities,” he adds.
The century bonds recently sold by Belgium and Ireland and issued at 2.3 per cent, are not only less liquid, they also present a greater duration risk.
Not only are 100-year bonds more sensitive to interest rate movements but this sensitivity can itself vary. Known as convexity, this can add an extra kick to the long dated bond if market rates fall. However, this also works against a buyer should interest rates rise over time.
"I can only think there is an investor out there with a specific need for them," says Mike Riddell, a fund manager at Allianz Global. "Either that or this is a really gloomy forecast about where Europe is going to be 100 years from now." – Copyright The Financial Times Limited 2016
