Investors take long view on Methuselah bonds

Methuselah bonds — so called in reference to the long life of their biblical namesake — are back in vogue in Europe, with eurozone governments spurred to issue amid a thirst for yield.

Methuselah is said to have lived to age 969. While these bonds' life spans are not quite so lengthy — nor rare — as Methuselah himself, they are nonetheless catching the attention of global money managers and institutional investors.

Spain's €3 billion ($3.4 billion) 50-year bond in May was more than three times oversubscribed, said sources, with interest from pension funds, insurance companies and banks. The bond is yielding about 3.5%, compared with 2.8% for a Spanish 30-year bond, said Hemal Popat, principal in London at Mercer Investments.

“That is the key for eurozone investors — I think it is the additional term premium, which is primarily compensation for the additional credit risk, that is attracting demand,” Mr. Popat said.

Spain followed on the heels of France and Belgium's 50-year issues in April, Belgium's 100-year issue, also in April, and the sale of a 100-year bond by Ireland in March.

While the issuance of long-dated bonds isn't new, there are a few key differences this time to past rounds.

With little yield to be found in much of the fixed-income market, investors are scratching around for returns. Low inflation and interest rates also are supporting these bonds in the short to medium term, since longer-duration investments are sensitive to changes in these rates. But over the longer term, rising rates could present problems.

“It is becoming more and more difficult to match assets and liabilities in a world where yields are so low,” said Fraser Lundie, London-based co-head of credit at Hermes Investment Management.

There are three options for investors: move further down the credit spectrum, which can be difficult from a regulatory point of view; take advantage of illiquidity premium on offer; or push further along the maturity curve, he said.

Low yields have “naturally ... led to a move out along yield curves, and people have been investing more in longer-dated maturities to earn the more attractive yield on offer,” said Mark Dowding, London-based partner and co-head of investment grade debt at BlueBay Asset Management LLP. The “temptation to extend” the maturity of their bond holdings is “pretty natural,” he said, particularly so because longer-dated bonds are at least providing a positive return right now.

“There is a limit to how much credit or high yield investors can have in their funds, so they look also at some sort of duration extension,” added Cosimo Marasciulo, head of government bonds at Pioneer Investments in Dublin.

Mr. Marasciulo said the yield curve is steep at the long end, in part thanks to the European Central Bank's asset purchase program, which is buying up bonds to 30-year maturities.

“They can change the rules, but (right now) the very long end is not part of the QE program. That is why it tends to be very steep,'' he said. “Maybe the ECB will change the rules and buy this kind of paper, maybe not — but the difference with the past is we have seen a lot of new issuance coming in a relatively short time.”

The ECB's intervention in bond markets through its various quantitative easing moves has led to “a bizarre distortion in the eurozone government bonds market at the moment, caused almost entirely because” the central bank is only buying up to 30-year bonds, said Mike Riddell, London-based fixed-income portfolio manager at Allianz Global Investors. Investors can pick up almost 50 basis points from Belgium's 50-year bond vs. the 30-year paper, he said.

The spate of issuance of longer-dated bonds is not just a good move for investors.

“It is a strong positive for the countries involved as well, as they are able to lock in extremely low cost of financing for extremely long periods of time,” Mr. Lundie said.

Mr. Dowding said issuers are “eyeing up the fact that yields are at historically low levels, and saying this looks like a very smart time to be trying to extend the maturity profile of our debt, and lock in some really cheap funding costs by issuing ultra-long-dated securities.”

The recent issuance has been more issuer-led than investor-led.

“It is more a case of issuers would like to issue long-dated bonds — if they can secure 50-year funding at 1%, 1.5% or 2%, it looks like a good deal,” Mr. Dowding said.

Harris Gorre, head of the multiasset group at Investec Bank, said European insurers have been big buyers of long-dated bonds.

“This is far more focused on the insurance community in Europe, following the implementation of Solvency II,” a European directive that in January introduced capital charges on assets according to the risk they are perceived to carry and the degree to which they match liability profiles. The knock-on effect from these regulations has been building for some time.

Chris Redmond, London-based global head of credit at Willis Towers Watson PLC, said based on available data regarding the latest 50-year Spanish bond, the majority of buyers were insurers, plus some pension funds.

“German insurers in particular face a bit of a predicament in so much as they have written policies which have a 4% return requirement, and achieving that is clearly very hard given the current investment landscape for high-quality assets,” he said.

A 50-year bond with a 3.5% coupon “appears pretty attractive” particularly compared with other bonds, a significant volume of which currently offer negative yields. Insurers and pension funds are “being pushed to take on risks that otherwise they might not want to, in order to achieve the desired returns that they” need, Mr. Redmond said.

But there are risks to investing for longer.

“If all this QE stuff fails and (the ECB) resorts to genuinely unconventional monetary policy, all this liquidity in the financial system could be released and cause inflation problems,” warned Tapan Datta, head of asset allocation at Aon Hewitt in London. “If you hold a 50-year bond, and there is an upsurge in inflation, you'd better make sure you have sold your holdings down before that happens.”

Mr. Datta acknowledged that investors need to find yield somewhere, but said “buyer beware as you can get hurt very quickly.”

Mr. Redmond agreed that the longer duration of these assets “feels slightly uncomfortable,” given the low levels of interest rates and yields.

However, the macro environment “right now seems probably quite supportive for those sorts of investments — there doesn't appear to be much in the way of inflation in Europe. Concerns about sovereign solvency have largely abated — albeit probably they are there in the background. Consequently, it doesn't feel like there is short- to medium-term downside risk to holding higher quality long-dated European sovereigns, but on the longer horizon there may well be,” he said.

For the time being, “the ECB will continue to buy bonds, (which) will keep yields relatively well anchored in Europe,” said David Zahn, head of European fixed-income at Franklin Templeton Investments in London.