Although the UK has a reputation as being the place to go for efficiently issuing long maturity deals, thanks to the long duration liabilities of much of its investor base, this issue has surpassed the next longest benchmark issue, a Gaz de France bond maturing in 2060, by some 54 years.
Long on duration, long on demand
Reportedly driven by reverse enquiry following the successful issuance of a 100-year US dollar bond last week, syndicates’ ability to bring such a revolutionary deal in large size (£1.35bn with a £4bn book of interest), gives some interesting insights, and poses some mixed implications for the sterling credit market.
From EDF’s perspective, it is obvious why, with rates beginning to rise from multi-generational lows, and credit spreads moving back to pre-crisis levels, they would want to issue large amounts of long- dated debt. Indeed, with the huge success of this deal, we would expect other issuers to seek to tap the market with similar deals. But why would bondholders, increasingly fearful of the potential for total return losses on long duration assets, want to buy a bond which will likely trade below par for most of its life?
Too long an outlook
For one thing, we would argue that investing over such an incredibly long period should require a material risk premium. Despite EDF’s relatively strong ratings (Aa3/A+), government ownership, and the defensive nature of the utilities industry, even the most knowledgeable credit analyst would surely only be able to paint the vaguest of pictures as to what EDF will look like in 30 years’ time, let alone 100.
There is little data for us to go on in terms of what such a premium should be, as until last Friday, the crop of ultra-long sterling corporate bonds were limited to issues maturing between 2050 and 2060, from generally high quality issuers, such as Gaz de France, EDF, Rabobank and Reseau Ferre de France.
Good liability matching
Investors seeking credit exposure may question the point of purchasing very high duration corporate bonds, where much of the return and volatility will be at the mercy of moves in government bond yields.
However, we must remember that for real money investors driven primarily by the desire to match liabilities, these bonds represent an attractive opportunity to do so, whilst clipping a higher coupon than the equivalent government bonds for many years to come. They are therefore immensely sought after, and are notoriously hard to source in the secondary market.
We must also remember that in duration terms, the additional risk or price volatility, declines incrementally by every additional year added to the maturity, therefore a switch out of a 50-year issue into a 100-year one, actually makes very limited impact.
Extend to 100 years and reduce duration
Believe it or not, given that as the coupon of a bond increases its duration falls, if one moves from the existing EDF 5.125% 2050 into a new 100-year bond with a 6% yield, it is estimated you actually reduce duration, from circa 18.9 years to around 17.1 years.
As the existing 2050 maturity actually yields only around 4.6%, given EDF’s willingness to pay up to secure such a long repayment period, investors have gained some 140bp a year, whilst owning a less volatile asset – no wonder there was a £4bn book of interest!
Looking at this from the perspective of a multi-asset class investor, one could argue that thanks to the effects of inflation, the real value of the principal repayment in the terms makes up a very small proportion of the total return.
In consequence, what is really of interest is the 6% coupon, and relative to equity, which also affords the holder great opportunity for price appreciation over a 100 year period, together with a dividend yield currently around 4%, it perhaps is not quite as compelling.
Our greatest concern however, is that the development of an increasing number of ultra-long bonds in indices will lengthen their duration materially, forcing benchmarked investors to lengthen portfolios. This is of course not an intuitive course of action against a backdrop of rising yields, and will no doubt re-kindle the debate about the deficiencies of traditional benchmark based investing.
