Global bond markets were roiled at the end of 2016 with higher rates and a re-steepening of the yield curve. The interest rate sell-off occurred during a change in global inflation expectations as discussions regarding deficit financing, infrastructure spending, and fiscal stimulus took center stage at a time when labor markets were generally considered tight given current low unemployment levels.
The recently confirmed Secretary of Treasury, Steven Mnuchin, indicated that he would: 1) look to extend the average maturity of Treasury’s portfolio beyond the already rapid extension that took place from 2009 onwards; and 2) possibly review the issuance of a 100-year bond as an instrument used to achieve that maturity extension.
At GMO, we will not venture a guess as to the likelihood of such issuance by the Treasury, but comments during the Borrowing Advisory Committee immediately following the presidential election suggested such an issuance was less likely than anticipated. However, more recent comments by Mnuchin and Gary Cohn1 have led us to believe that the possibility of an issuance is becoming more and more likely. From the perspective of our Benchmark-Free Allocation Strategy, which has a CPI-based performance target, we believe such bonds would not always make sense.2 However, our colleagues responsible for GMO’s Emerging Country Debt strategies, which are managed against a benchmark with a long duration, appreciate the significant alpha opportunities that some of these bonds represent.
An issuer’s utility function includes concerns about debt market maturity structure as well as, particularly in developed markets, creating a term structure for capital markets. Investor concerns, on the other hand, are focused on liability management and, for active managers, alpha generation. The following discussion is applicable to “ultralongs,” including the 100-year and 50-year maturity points.
There is nothing new about ultralong debt issuance. Indeed, the British government issued perpetual debt, called “Consols” during the Napoleonic War. The United States itself has forayed into the greater than 30-year issuance space with the Treasury issuing several bonds with those maturities, including a perpetual bond in 1900 and a 50-year bond in 1911.3 Some academic observers, such as John Cochrane, have argued that the US Treasury should issue perpetual securities as part of its regular and predictable issuance program. While Consols no longer exist, several governments have taken advantage of low absolute rates and the relative historical flatness of forward curves to issue longer-dated debt both in the developed and emerging market space. Countries as diverse as Mexico, Ireland, Belgium, and the UK have issued these so-called ultralongs. Certain corporates and private issuers have also tapped the long end of the curve, with names as disparate as Disney, Coca-Cola, and Petrobras. Non-profits such as Cal Tech, the Cleveland Clinic, DC Water and Sewer, Tufts, MIT, and New York Presbyterian have also taken part in this market.
At GMO, we have invested, at times, in 100-year issues, particularly through our Emerging Country Debt team. As we will explain later, century bonds, at the right price, allow a judicious and thoughtful long-term investor to harvest risk premia and garner outperformance relative to that issuer’s other, more vanilla, short-term issuances. In this paper, we explore both the issuer and investor motivation for borrowing and lending money for a century.