Risk, where it is not expected

27th September 2017
-News, IAM

Erika Mesmer, Client Relationship Manager

Looking back 100 years in history, we come across two world wars, hyperinflation in several countries and many different financial crises. It is hard to grasp how much our world has changed in 100 years. Austria is about to issue a bond running for 100 years, which makes us wonder about what will happen until it comes to maturity in 2117. This does however not prevent the market to show an interest: about 11 billion euros bid for this bond, which is expected to pay a coupon of 2.1%.

Although this bond is the first of this length in the Eurozone, there are a few other bonds, with long lasting maturities, which are worthwhile looking at. Austria, for example, already issued a 70 year bond in 2016, with a maturity in 2086. It has a coupon of 1.5%. Interest in the market was solid, as for its 2 billion, 7.8 billion were subscribed.

In Switzerland, the Swiss Confederation issued a 50 year bond in 2014, with a coupon of 2%. After three years of history, it has performed 44.8% and is currently yielding 0.47%.

For issuers the advantages are easy to see: they can fix the current low rate for a very long term and the reimbursement of the principal is very far away. If in the future inflation rises, the state will automatically see its level of debt reduced. The only downside to longer dated bonds, for the issuer, is the higher coupon it has to pay, compared to shorter maturities. However, if it expects rates to rise in the future, the current rate to be payed will become very attractive.

What about investors? For those seeking a regular income stream for the very long term (pension funds and insurance companies are often mentioned as having these criteria), long dated bonds offer this security. It provides investors, aiming to keep the investment until maturity, with certainty and avoids them being exposed to market movements. For liability matching purposes maturities in the far future also play an important role.

The risks for investors however are significant. Default risk cannot be ignored and liquidity might be an issue. The most important risk nevertheless is a change in interest rates. A fall in rates means the rise of the bond price. Yet it is difficult to imagine interest rates to remain at the current low rates for the next 50, 70 or 100 years. Rising rates will then negatively impact the bond price and its attractiveness.

The Swiss 50 year bond, with maturity 2064, presents since its launch in June 2014 a performance of 44%. What in this falling interest rate environment is amazing hides also significant risk. The bond has 47 more years to maturity and much will happen between now and then. The volatility of the bond, since its launch in 2014, is 17%, while Swiss and European equities, over the same period, have a volatility of less than 14%. This does not give us the feeling, that the bond is a safe investment over the long run, rather the contrary!

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