In a seemingly endless ultra-low interest rate environment, investors remain desperately in search of yield.
They are finding a sudden rush of perpetual bonds from Asian borrowers, which typically pay a 4% to 5% return, a new sweet spot. These bonds are helping them outperform benchmark indices at a time when credit spreads have compressed significantly in the past 12 months.
Extending the sale of perpetual bonds in dollars, Singapore-based Olam, one of the world's biggest food traders, raised S$300 million from a non-call five-year bond this week, paying a coupon of 5.5%. As of Thursday afternoon, the bond was trading at par.
However, questions have been raised whether many of the market’s less experienced investors are aware of the duration risks that these bonds pose. For longer-duration bonds are the most sensitive of all bonds to rising interest rates and typically trade down first and fastest in such an environment.
Many of this year’s deals have had notably high allocations to private banking investors who are not fixed income professionals. This has been particularly true of fixed-for-life structures.
These pose even more of an investment risk than standard perpetuals because issuers are not incentivized to call their deals. Traditionally, perpetual bonds are perpetual in name only, as they carry call options after three- or five-years with punitive step-up rates, or re-sets.
They are, in effect, short-dated bonds.
But fixed-for-life structures have no punitive call features. This means issuers are only likely to call them if interest rates go down so they can secure cheaper funding.
In this instance, investors will not keep hold of the yield pick up for long. And if interest rates go up and issuers do not call the bonds, investors are likely to get stuck with paper that has no maturity date and will be painful to sell out of because it is trading below issue price.
One deal has already shown the market what may happen if the US Federal Reserve embarks on a faster and higher rate cycle.
Last November, Li & Fung issued a 5.25% fixed-for-life subordinated perpetual just a few days before the US presidential election. After Donald Trump’s surprise win, markets judged a higher interest rate environment was in the offering and perpetuals sold off.
The Hong Kong trading group’s deal rapidly slid 12 points to a cash price low around the 86% level. Since then, it has re-bounded somewhat and as of mid-June, was trading around the 92% level.
But it has never fully recovered and remains eight points below its issue price.
