Mozart. Sachertorte. The Alps.
There’s a lot to love about Austria: an 85% total return on a bond in two years is just another one of them…
Let’s say someone wanted to borrow a thousand dollars from you with interest, and when you ask when they plan to give the balance back, they say “a hundred years.”
Are you going to charge them the same interest you’d charge your buddy who borrowed the same amount for three years?
Probably not. Chances are, you’d charge them more.
After all, while you’re not using that money, you’re missing out on opportunities with that money, not limited to either spending or investing it.
This is called opportunity cost and is the driving force for a tremendous number of decisions we make throughout our economic life.
Now, another thing that goes into the decision to lend your buddy a thousand dollars for a hundred years, is if you think they’re actually going to make it. After all, life happens, right? Your buddy might not last a hundred years to pay it back.
Thirty? Yeah, sure, banks loan that all the time.
One hundred? Probably not.
So why, then, did investors flock to buy Austria’s 100-year bond? A bond that ended up being 9-times oversubscribed, meaning the wait list to buy one was essentially nine times longer than the number of bonds available?
Why, also, did investors not flood to buy Argentina’s 100-year bond? Why does the United States not even have a 100-year bond?
Well, let’s start with that first question.
Do Investors really expect to hold those bonds until maturity? That they’d live 100-years to collect Austria’s payback? Or that Austria can survive as a nation for 100 years?
While a nation has a greater chance to survive 100 years and beyond than an investor, even a nation as “stable” and well known as Austria has a history riddled with uncertainty. After all, it was less than 100 years ago that Adolf Hitler annexed Austria into his Third Reich, despite the fact that the Treaty of Versailles forbade the unification of Austria and Germany. It was not until 1955 that Austria became a state. That was 65 years ago. Can investors really bet on Austria paying back their initial investment?
Investors don’t really have to in this situation. After all, bonds can be sold. So why buy a hundred-year bond then?
The short answer? Yield! Or “Cash Flow,” as we like to focus on at Emergent.
Applying the concept of the interest at which you’d lend your buddy to an entire nation, investors, especially in Europe where in some cases interest rates are negative, are more likely to flood into higher-rate securities to grab as much yield as they can.
The catch? That much demand pushed up the price of the bond, creating a total return of 85% for investors since 2017 when it was first issued.
Long-timed bonds are also much more sensitive to changes in interest rates as a result of how far into the future they are. After all, the future is less certain than today, so any fluctuation will create a lot of movement. Hence, the jump in prices can also be read as investors betting that interest rates will stay low or go lower than they are today.
The thing about bonds, however, is that while prices can go up and down, the coupon (or interest) remains the same! Investors try to “lock in” those rates, which are guaranteed.
Even with a yield less than one at this point, Austria’s 100-year bond is still a catch to those living in a ZIRP (zero rate interest policy) environment. This is important because with those “locked-in” rates, investors don’t have to worry about rates going down. The chances are they won’t have re-investment fears since it’ll be 100 years before the bond matures and they are betting that today’s interest rates will be higher than future ones.
The only way they’d “lose out” on the bet is if interest rates go up dramatically, but part of the reason these bonds have done well is because the central banks around the world have made it clear that that possibility is extremely remote.
Don’t Cry for Argentina?
What’s up with Argentina, then? No one is jumping at the bit to buy Argentina’s 100-year bonds. It might have some scratching their heads.
Others who have had a good memory might laugh and know the answer is: 2016.
In 2016, Argentina finished its 15-year litigation and technical default on $95 billion worth of sovereign debt. Now, while the new president is trying to lead the country towards a stable pro-business route to prosperity, the reality is that investors who don’t have the wealth or insurance of Fidelity and BlackRock are naturally more skeptical of Argentina’s abilities to pay this money back.
After all, if your buddy just finished going bankrupt, would you really be more or less inclined to loan him that thousand bucks? Even if his interest rate is juicy?
So, what does this mean for me?
As usual, we at Emergent like to discuss the practical effects of what’s going on with the markets in terms of our clients’ and readers’ financial planning life. So, what does a 100-year Austrian, or Argentine, bond have to do with our life?
Well, to begin with, most clients shouldn’t need to have exposure to European bonds. Betting on a 100-year Austrian bond requires a lot of money and a lot of knowledge of the specific goings-on in Europe, in addition to trying to lock in a rate for a long time. Most clients can look to other areas of the markets to secure both cash flow and risk-generated gains.
It does show, however, that yield is something investors are currently in the market for, and many believe that the 100-year bond is yet another sign that low to zero interest rates may be here to stay.
What that means is that financial planners can look to those market signals and try to find as much yield and value now while they can. It’s also a sign that the demand for debt is still very high, especially in Europe.
It’s fair to say that neither Austria nor the European Central Bank was expecting such demand for 100-year bonds. Even Steve Mnuchin, the Treasury Secretary for the United States, had said that the U.S. has not considered 100-year bonds simply because they did not think there would be enough demand.
That may be considered unlikely given how well Austria’s bonds have done.
Domestically there are institutions, however, that have already issued these 100-year bonds, not limited to the University of Virginia, Rutgers University, Caltech, and USC. Other countries, such as France, Italy, and the UK have tried out 50-year bonds and Ireland and Belgium have made private placements of the 100-year.
Either way, the US is reluctant to start selling 100-year bonds, which for the time being, means that information like the Austrian 100-year is a sign that low rates are going to be the norm for quite a while.
Money markets might not cut it in the future for saving for retirement.
There’s only one way to know: talk to a financial planner.