Down the Rabbit Hole – Fixed Interest

June 23rd, 2017, by Georgina Ogilvie-Jones

Argentina issued a 100-year bond this week with a coupon of 7 1/8% and a yield of nearly 8% (which will change in line with the price of the debt and is not guaranteed). It was extremely oversubscribed with $9.75 billion of orders placed for the $2.75 billion actually issued. In our view the excess demand for such a long maturity bond issue from a country with a very problematic credit record is a good example of the dislocation and irrationality which prevails within bond markets.

We have already seen corporate debt issued in the last few years with maturities of anything from 40 to 100 years for mega caps such as Microsoft, Petrobras, BAT and Siemens. This makes perfect sense for the companies as a source of cheap funding but for investors, the yields are not impressive. There is also no guarantee the company will still exist in its present form at maturity, as indicated by a quick check of the largest companies 50 and 100 years ago and the largest companies today. Many of today’s largest companies such as Apple and Google/Alphabet were founded quite recently. Indeed IBM is the only recognisable technology company in the Fortune company ranking for 1967. Others in the top 50 from that year have merged to form new megacaps such as Conoco, Exxon, Mobil, Kraft, GM and Chrysler. More worryingly in the context of very long term debt, others are now defunct, such as Bethlehem Steel.

Argentina is unlikely to disappear or be taken over but has defaulted on its sovereign debt 8 times in its 200 year history, including five defaults in the last century and two defaults since 2000. In 2001 Argentina defaulted on $100 billion of bonds, at that time the largest sovereign default on record. More recently, in 2014, a technical default occurred when hedge fund manager Elliott Capital demanded a full pay-out on $1.3 billion of bonds purchased in 2005 for less than their face value. Argentina’s centre right President Macri resolved this legal issue last year. $4.65 billion was paid out to Elliott Capital and other “holdout” creditors. Notably, the investors only received 75% of the par value of the debt they held. The settlement allowed Argentina to return to capital markets with a record $16 billion debt issue. Although a more benign economic and political environment has emerged for companies in Argentina, MSCI did not upgrade the country from “frontier” to “emerging” status when it reviewed its indices this month.

History would suggest that investors in Argentine sovereign debt are unlikely to be repaid their principal at maturity. It is, however, likely that most purchasers of the debt issue are only intending to hold it for a short period. They are relying on the “greater fool theory” to find another investor willing to pay a higher price for it in a few months or years despite the inherent risks. If the price falls, or if the government once again defaults, irrecoverable capital loss may occur…

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