Pay me back next century
For most clients we advocate holding well diversified portfolios with exposure to a range of asset classes so there is usually plenty for me to write write about in these newsletters. Debt is not the most engaging of topics to read about so I have noticed an unconscious bias towards equities in our back catalogue. They are generally more exciting, and the prevailing themes are more visible in the listed companies on stock markets. We have written about gold and precious metals but an event last week has provided the perfect cue to write about bonds.
Fixed income securities are an important component of a balanced portfolio and provide a degree of certainty to those mandates requiring income with a medium or lower risk tolerance. Let’s face it, bonds are important but for many people they are reassuringly boring. It is hard to get too excited about topics like duration and credit risk but bond markets provide deep pools of liquidity for the efficient management of our economy, or indeed every advanced nation’s economy.
In simple terms a bond is an IOU, and there are three basic questions a lender needs to know.
Do I trust the borrower?
When will I get my money back?
What’s in it for me?
You will be pleased to know that this is not an education piece on debt or credit so we can concentrate on question two .
Most bonds are issued with a life of 4 to 10 years although some longer term issuance can have a life of 30 years. A glance at the roster of UK government bonds (also known as Gilts) shows a range of maturities stretching into the 2050’s and 60’s. The longest maturity is April 2073. One of the advantages of lending money to a sovereign government being that there is a good chance they will pay you back. They always have in the UK, and governments always lean on the tax payer when they deem it necessary.
In an ageing society like ours, the pension funds like to have assets that provide them with a steady and reliable cashflow to meet their ongoing liabilities so gilts and bonds are a cornerstone of the provision of insurance and pension annuities.
Bonds are issued all the time in multiple tranches so it was little wonder that the issuance of a fixed income security by Google last week went largely unnoticed. Indeed, I must credit one of our managers at 7IM for bringing it to my attention.
Alphabet, the parent company of Google issued a bond with a 100 year life. This so called Century bond is offering to pay you 6.125% per annum and return your principal loan to you in February 2126. At the present time that may sound like a reasonable annual return but what are the chances of Alphabet being around in a hundred years time and what will your principal be worth in future money ?
Another interesting feature of this bond is that Google have raised £1 billion in sterling rather than dollars. It is comforting to know that London can still attract a major titan like Alphabet to our capital markets. There was another dollar denominated bond on offer and together they were oversubscribed 100 times.
One may wonder why a company with a market capitalisation of $4 trillion and generating an annual free cash flow of $73 billion needs to raise any cash?
The answer is Artificial Intelligence. Google plans to spend an eye watering sum of $185 billion in their quest for dominance; and they would like to use your money to pay for it.
Century bonds are a rarity and of the 38 lines of issuance since 1990, only 17 companies are still around. Most have gone bust or been swallowed up in a takeover or merger. Bondholders still get paid on a takeover but not on a default. Notable survivors are Disney, Coca Cola & IBM.
Methinks these Google bonds are unlikely to land in our client portfolios but may well be buried in the large institutional pension funds that like to match their longterm liabilities.