A curious example of messed-up interest rate markets has emerged recently. Certain countries and companies have successfully issued bonds at fixed rates of interest for ultra-long terms. Fifty or one hundred years is a long time.
To put these in perspective, it might be helpful to go back to the 1950’s. The largest insurance company in the world, Prudential, invested in a bond issued by General Motors. It was $100 million dollars in a century bond – maturing one hundred years after issue – for 4% interest. A couple of lessons about risk might be learned from this story.
Interest rate risk is a thing that affects bonds. When rates rise, the value of existing bonds declines. What is a 4% bond worth in a 15% world? By the early 1980’s, with seventy years remaining on this GM bond, the answer would have been less than 30 cents on the dollar.
But if a long term bond is held to maturity and pays the principle back as promised, the potential market value loss from higher interest rates is avoided, right? Sure. But that is not what happened.
The second lesson about risk came into play in 2009, when General Motors filed for bankruptcy. Creditors received less than 20 cents on the dollar in the liquidation of GM. So this supposed century-long investment came to a bad end, more than forty years early. When you lend money to somebody that turns out to be a deadbeat, you learn about credit risk.
These lessons of history are pertinent now, as Austria joins Italy and Mexico as issuers of century bonds. The most recent Austrian issue yields just 1.2%. Do you wonder how this could possibly work out?
We have characterized the movement into fixed income securities in recent years as a stampede before. Irrational pricing and large volumes of issuance are the hallmarks of a stampede, in our view. This is our opinion – it may be wrong. We have no guarantees.
As we watch the current revival of century bonds unfold, we’ll be thinking about the history of these instruments, and scratching our heads. Clients, if you would like to talk about this or anything else, please email us or call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
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