100-Year Bonds Are a Dangerous Temptation
Nothing illustrates the desperate hunt for yield among high-quality global issues better than Austria’s 100-year bond. The debt was issued at just below “par” (the nominal value of 100 used when first issuing bonds) in 2017, but in the two years subsequently it has more than doubled in worth to 210. That’s an annualized return of nearly 50%. The price has risen 30% since June alone, when Austria reopened the bond to new buyers.
Argentina also issued an ultra-long dated bond in 2017 but things haven’t gone quite so famously. It plunged by one-third in value last week to a low of 45 after a primary election loss for the market-friendly reformist President Mauricio Macri, before recovering slightly to 50. About the only good thing that can be said about this bond is that at least it was issued in dollars, and not in Argentine pesos which have dropped by about 20% against the greenback since Macri’s setback.
So are there any lessons to be drawn here for market participants, especially with the news that the U.S. Treasury Department is assessing possible appetite for 50- or 100-year bonds?
Instant hindsight tells us that plumping for Austrian quality has paid off more than flirting with Argentine danger, but there are mitigating factors at play. Those who snapped up the 100-year Austria bond this year paid for the pleasure, with a minuscule yield on offer for such long-dated debt. Some investors like ultra-long maturities with low coupons because their prices rise more sharply when their yield falls, a phenomenon I explained here. But even they couldn’t have guessed that European yields would go even further into meltdown amid fears of recession, thereby pushing the price of the bonds ever higher.
Still, this type of debt carries heavy risks. After all, it will only redeem at 100% of its face value (or par) so investors who have bought in at much higher prices would suffer if yields returned to levels seen as recently as the start of this year – and the price of the bond fell. Furthermore, while interest might not be the priority for many investors in ultra-long maturities, the Austrian paper is only yielding 60 basis points currently. That won’t butter many parsnips.
Equally, one can sympathize with those who punted on Argentina back in 2017. Yes, it may seem a little foolish to bet that the country would manage to pay this bond back, or keep paying the coupon, given its history of defaults. But a 7.9% yield in 2017 was sufficiently enticing for $2.75 billion to be sold. The theory for investors would be so long as those coupons rolled in for a decade then the initial investment would be recouped and anything more would be free money for as many years as the payouts continued.
Unfortunately, Macri hasn’t delivered economically and the Argentine public has proven much more resistant to his charms than the markets. No investor banked on a political upset happening so quickly, but this is the joy of investing in “frontier economies:” there’s a reason 8% of interest was on offer (and even more now). If the result of the primaries is repeated at the election on October 27 then it would herald a return to a similar socialist government that resulted in the country’s last default in 2014.
So what’s better, piling into ultra-safe Austria-style long bonds or chancing it with an Argentina-type offer? The answer, sadly, is neither. Circumstance is everything in the financial markets. Yes, something that looked as alluringly cheap as Argentina’s century bonds has proven to be be cheap for a reason. But the seductive expense of the Austrian equivalent shouldn’t bring any false sense of comfort. Risk takes many forms.