Gadfly

Austria's Mind-Blowing Bond

Just look at what could happen to your capital.
From
AFP / Staff

The 100-year debt sold by Austria this week "blows my mind," Bob Doll, the chief equity strategist at Nuveen Asset Management told Bloomberg Television on Wednesday. The bond also has the potential to blow investors' performance out of the water -- and not in a good way.

The combination of a low interest rate of 2.1 percent plus a maturity date of 2117 makes the security highly sensitive to changes in yield, a phenomenon known as duration. That means bondholders are in line for substantial capital gains if yields decline -- but on the hook for big losses if they rise. 

So, as a thought experiment, what would happen to its price if the bond underwent the same yield changes as Austria's 30-year issue experienced in the past year?

After 12 months, the owner of the century bond would be facing a loss of more than a quarter of the initial capital invested. If that sounds implausible, check out the performance of Austria's 70-year issue in recent days after its longer-dated competitor for bondholders' money was announced:

Austria's 100-year bond is the most price-sensitive vanilla government security out there. But there's a bond that swings even more in price -- the U.K. government's inflation-linked 0.125 percent security due in 2068.

The combination of a wait to get repaid in 51 years time plus a skimpy 0.125 percent interest rate means a 1 basis point change in yield moves the price of the U.K. linker by 66 cents, even more than the 43 cents swing the Austria bond is susceptible to.

More than 40 percent of Austria's 100-year security went to U.K. accounts, with Germany the next most prominent, at 13 percent. Nearly 30 percent was bought by euro zone investors, so the geographical distribution was even broader than for Austria's 70-year security.

The traditional investor base of insurers and pension funds only accounted for 7 percent of the century bond, compared with a third for the 70-year deal. That is a worrying sign, suggesting that the bond may not prove to be quite so locked away in a vault as ultra-longs normally are.

Fund managers took the lion's share, at 65 percent. This really does suggest the attraction of this deal was about portfolio managers looking for the extra sensitivity to enhance the flexibility of their holdings. 

Those buyers will be hoping central banks don't succeed in stoking inflation sufficiently to change the interest-rate outlook.

"If they have some more success, that 2 percent paper is just not going to look very attractive," Doll said. Let’s hope that doesn't turn out to be the understatement of the year -- or indeed the century.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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