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THE
REAPPEARANCE OF THE 50-YEAR BOND On May 16, the Financial Times devoted a full page of their newspaper to a topic of current and future relevance: the return of the long maturity bond. Following the successful auction in February of French 50-year bonds, news emerged of other nations planning to follow suit with similar issues. In anticipation of the UK’s own issuance of 50-year government bonds, a group of reporters at the London paper examined the recent spate of long bond issuance by governments and corporate entities. Their excellent report, together with some similarly focused articles, shows what investors might expect from the trend. In the wake of France’s success with its 50 year-bond, countries such as Germany and United Kingdom are seen as likely to follow with 50-year bonds of their own. The Italian treasury is considering the issuance of a long-term bond, after corporate borrower Telecom Italia sold a 50-year bond in March. Other nations, The Netherlands and Spain among them, have recently issued 30-year bonds, and the US Treasury is considering the re-issuance of 30-year bonds as well. [1] It certainly seems that favor has shifted to the issuance of long and ultra-long term debt. So what accounts for this sudden, concentrated interest in issuing long maturity bonds? Interest rates are currently low, especially in comparison with levels of the past few decades. The desire to fund national debts at current rates is one strong motivator, as the Financial Times story pointed out. Another positive for issuers may be the recent low level in inflation, at least as shown by CPI and other official indexes. The recent experience of lower inflation in the US and European nations has probably fostered greater appetite for long bonds among investors, replacing the anxiety of capital erosion experienced by previous generations of bondholders. “Governments are showing an astute understanding of timing by issuing very long dated when inflation and interest rates are particularly low,” says Jeremy Toner, co manager of the Investec Global Bond Fund. [2] The possibility of pension shortfalls has also helped to create demand for very long-term bonds. Developed countries such as Japan, the US, and many of the European nations are facing substantial worker retirement among their aging populations. Pension funds will have to match their future liabilities (payments to retirees) to long dated assets. This is known as “asset-liability matching” and pension fund managers are currently favoring bonds to try and meet this goal. Many managers believe bonds are more stable and provide less volatile return than equities. [3] Are purchasers of ultra-long maturity bonds being compensated with extra yield for investing longer and taking the inflation risk? Not quite, it seems. As the Times article pointed out, due to high demand for long-term bonds, the UK yield curve is currently inverted and offers less reward for investing longer. [4] Despite this, pension funds seeking to avoid shortfalls and appease regulators are not the only buyers in the market. Hedge funds and insurers were said to account for a notable chunk of demand in the French treasury’s 50-year auction. [5] Although the French bonds were “priced to yield just 4.21 percent – only three basis points above the yield on France’s 30-year debt”, the issuance was oversubscribed. [6] The situation is not so different for corporate issues as one skeptical investment manager has noted. “That the BBB-rated Telecom Italia was able to raise almost 600 million [pounds] for 50 years - and at a coupon of just 5.25% - illustrates how little the market is demanding for risk at present”. [7] Further to the topic of inflation risk, there is an interesting section in the Financial Times article that summarizes the risk of capital erosion that has historically befallen bondholders. Capital losses have hit more than the investors of the 1970s era, and in more than one English-speaking nation. See The Australian’s story, “History repeats itself in topsy-turvy world” [8] for a complementary reading of the English and Australian experience. The issuance of inflation index-linked bonds is expected to follow the initial wave of 50-year bonds, but the protection from inflation is dependent on the integrity of the official measurement index. This is a problem for those purchasing the debt of nations that employ methodologies of calculating inflation rates increasingly seen as suspect. There is also the issue of nation risk. While buyers of long-maturity corporate bonds are betting that the issuing corporation will continue to exist as a financially sound entity, the same consideration must be given to debt of sovereign nations. The Financial Times voiced the opinion that debt burdens in many of the countries reviewed were likely to rise in the future. While governments may find themselves wanting to issue long-term debt for this reason, it also increases risk of default on the very bonds they sell. Unfortunately, “ratings agencies do not officially recognize this danger” when awarding ratings to long-term sovereign bonds. Instead, their ratings “are based on a five year view, irrespective of the maturity”. [9] Having discussed the possible risks to investors, we should return to one main point of consideration for the issuers. Are those that are issuing very-long term debt taking proper advantage of a low-rate window of opportunity? It is widely thought that they are, or at least, should be doing so. While reading up on the subject, I happened to come across some comments made by Dr. Marc Faber, comparing recent bond yields with their last great low. Noting that US bond yields reached a historical low in 1941, Faber said that in retrospect, this point marked a lifetime selling opportunity for US bonds, since government bond yields would subsequently rise from the 2% area to well over 7%, this on the way to reaching 15% in 1981. For reasons given at the time of writing in late 2001, Dr. Faber felt that 2001 could mark another low in interest rates, at least in the US, and that the treasury should issue long term securities while rates were low. [10] Interestingly, it was only earlier that year that the US Treasury had stopped selling 30-year bonds due to the appearance of a budget surplus and also, as a cost saving measure. [1] Chung, Joanna, Jennifer Hughes, and Gillian Tett. “Into the unknown: long bonds are back but can we be sure of the world of 2055?” Financial Times 16 May, 2005, USA edition: 15. [2] “UK Government to issue 50-year bond.” Trustnet News / General . 13 May 2005. Financial Express. 24 May 2005 http://www.trustnet.co.uk/general/news/display-story.asp?db=general&id=68041. [3] Chung, Joanna, Jennifer Hughes, and Gillian Tett. “Into the unknown: long bonds are back but can we be sure of the world of 2055?” Financial Times 16 May, 2005, USA edition: 15. [4] Chung, Joanna, Jennifer Hughes, and Gillian Tett. “Into the unknown: long bonds are back but can we be sure of the world of 2055?” Financial Times 16 May, 2005, USA edition: 15. [5] Mitchell, Allston. “Europe’s 50 year bonds” Tiscali Europe . 11 March 2005. Tiscali. 24 May 2005 http://europe.tiscali.co.uk/index.jsp?section=Business&level=preview&content=334204. [6] Chung, Joanna, Jennifer Hughes, and Gillian Tett. “Into the unknown: long bonds are back but can we be sure of the world of 2055?” Financial Times 16 May, 2005, USA edition: 15. [7] “UK Government to issue 50-year bond.” Trustnet News / General . 13 May 2005. Financial Express. 24 May 2005 http://www.trustnet.co.uk/general/news/display-story.asp?db=general&id=68041. [8] Wood, Alan. “History repeats itself in topsy-turvy world”. The Australian . 30 March 2005. 24 May 2005. http://www.theaustralian.news.com.au/common/story_page/0,5744,12694224%255E31478,00.html. [9] Chung, Joanna, Jennifer Hughes, and Gillian Tett. “Into the unknown: long bonds are back but can we be sure of the world of 2055?” Financial Times 16 May, 2005, USA edition: 15. [10] Faber, Dr. Marc. “Does crisis and war create a buying opportunity?” AME Info fn. 6 November 2001. AME Info. 24 May 2005 http://www.ameinfo.com/16526.html.
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