Methuselah bond collapse ignites speculative interest

The tension in the bond market hit bonds hard. In particular very long bonds (over 40 years), the so-called Matusalem bonds, which lost a lot of value in price terms, on average over -50% for the main government issues in euro (see table).

Since these are highly rated sovereign bonds, these losses, for those who bought the bond at issuance, are 'unrealised', i.e. having time and not needing the capital will turn into gains at maturity. For an investor on the other hand who is left out, seeing a highly rated bond priced well below par can be very attractive. "Before entering," explains Mario Allegra, Alfa Scf investment manager, "you have to consider the worst-case scenario (excluding default), i.e. buying a bond to hold until maturity. In this case, being stranded for decades in an investment that currently yields between 3.7% and 4.5% gross is not so attractive, considering long-term average inflation of 2% and taxation".

The speculative appeal is linked to another hypothesis, namely the scenario of a possible recession in the coming years with the prospect that yields may return towards zero thanks to massive monetary stimulus. "In this case," adds Allegra, "given the high convexity of these bonds, the price would rise rapidly to even small negative changes in rates. Capital gains could be in the double digits'.

Just look at the French Oat 2072 dropping below 30 or the BTp of the same maturity worth just over 50. A drop in yields of 100 basis points, for example, leads to double-digit capital gains. 'Beware, however,' Allegra explains, 'that the rates on the very long end of the curve are not necessarily correlated with the short end, i.e. those set by the central banks. In fact, over the past 12 months while the ECB has made eight rate cuts, the yield on the Austrian 100-year rose from 2.2 per cent to 3.2 per cent'.

One advantage of buying these bonds today is to buy at a discount and thus receive a coupon that is proportionally much higher than the nominal one. "Trying," concludes Allegra, "to do a simulation exercise of how convexity works, if in 3 years the 100-year rate (approximate) were to be at 4% (now at 3.2%) the bond would be priced at about 23, which compared to the current quotation would mean a -24% on the price, but with about 6% of coupons collected to be added. Conversely, if in 3 years' time very long rates were at 2.5%, the price would be at about 41, with a +36% capital gain in addition to the usual +6% coupon flow.