It may make sense, but isn't it as much "Punting" as "Investing”?

ref: - "Investors go through looking glass world of negative yields”, Markets and Investing, The Financial Times

ref: - "Bond buyers play long game to notch up huge gains with bet on lower rates”, Companies and Markets, The Financial Times 12/8/19

If you wanted to get a handle on just how spectacularly the market's anxieties about future growth have sent global yields tumbling, you could do worse than look at the performance of Austria's "century" bond, issued in 2017 with a coupon (annual interest rate) of 2.1%. You wouldn't be the only one, it's become a bit of a financial media darling over the last week or so.

You may or may not remember that at the time of issue, many were making the point that an annual return of 2.1% was pretty slim -- to put it mildly -- for lending money for 100 years. But plainly many more felt differently -- the bond was well oversubscribed. One wonders what the doubters must have been thinking as recently as late June when another tranche of the issue was released (with just the 98 years to go), this time with a coupon of just under 1.2%. Madness, surely? Er… no. Once again, the paper was well bid for.

Quite what they're thinking now is anyone's guess. This morning, Austria 2.1% of 2117 was yielding just 0.75%. How's that for a meagre annual return on a 98-year investment? But just for once, and remembering that as bond YIELDS fall, bond PRICES rise, it might be useful to look at what such a move in its yield has done for its price. As with most bonds, this one was issued at PAR, or 100. Its price this morning (that equates to that yield of 0.75%) was just over 194. That means that if you had bought on the issue, sold today and took into account the small amount of interest earned in the meantime you would have made nigh on 100% on your capital in just under two years.

AH!!! I SEE…

The thing is, those investors that bought the Austrian bond weren't so much buying an instrument that would pay them 2.1% (or much less) over 98 -100 years, they were buying DURATION (not to be confused with Time to Maturity). A quick


Duration is a measure of a bond's sensitivity to Interest Rate changes. The higher the bond's duration, the greater it's sensitivity to those changes (or it's volatility, if you prefer), and vice versa.

Factors in calculating Duration include the coupon rate, and the length of time to maturity -- the lower the coupon, and the longer the bond, the higher the duration -- or the more the bond will move in response to a change in interest rates. Thus, the performance of a low coupon century bond like Austria's has made it the brilliant shining star of a whole sector that has gone through the roof.

These days, investors will grab any decent yield that they can find. The problem is that with over $15 trillion of the global bond market offering negative yields it's getting increasingly difficult to find suitably secure debt offering a positive return. Even some corporate and emerging market debt has headed below zero. Now, with US 10yr Treasuries offering below 1.7% and threatening the low of 1.375%, there's even talk of US yields going negative -- not so long ago a truly unbelievable notion.

We all understand that investors need a safe home for their money and maybe prepared to put up with a small amount of the pain inflicted by negative rates (or the cost of lending one's money to someone else!), but surely there's a limit to it -- at some stage, even the big players will follow the example of the small saver and stuff their money under their metaphorical mattress. Unless there's another way to make money of course, as there has been with Austria's bond (or just about anyone else's bond, for that matter).

But that's a bit different from old-style investing, where you might buy and hold a rock-solid bond in the knowledge that it might provide suitable income, or match potential liabilities in the future if you were an insurance company, for example.

One of the standard answers to the question of why one might buy a bond with a miserly low yield has always been: "Just because it's low, it doesn't mean that it can't go lower." You can turn it around into price terms and say "Just because it's expensive, it doesn't mean it's not going to get more expensive." And boy, hasn't that been true!

And that's absolutely fine… so long as you realise that your "investing" has morphed into something more akin to an out-and-out bet on the direction of interest rates. And that's fine too… for the reasons above, these days it's very difficult to make money without taking a directional view. But just keep reminding yourself: if everyone's playing the same game, when and if this thing ever turns (and they always do eventually), it could get very nasty indeed.

Featured Posts
Recent Posts