Blain’s Morning Porridge – June 27th 2019

Blain’s Morning Porridge  – June 27th 2019

“Flirting with madness is one thing, but when madness starts flirting back, it’s time to call it off…”

In the headlines this morning:

The clock is ticking down to the Trump/Xi chat at the G20 which starts tomorrow. On Saturday we will hear how it went – the market expects agreement on a new round of talks. That won’t mean much, but markets will no doubt love it and rally. But, who knows what follows?

I suspect nothing is really sorted and anticipate a lower-for-longer, ongoing financial repressive environment, so I guess I better put my strategy hat on and come up with some brilliant new wizard wheeze/astute financial investment to arbitrage it … and I think I have! I’ve taken my lead from something earlier this week.

Austria launched a Euro1.25 bln tap/tranche of the 2.2% 100-year deal it launched two years ago. It was apparently 4 times oversubscribed – over 100 investors put in orders for $5.5 bln of the century bonds! The new deal was priced to yield 1.1712% – meaning investors are paying a price of 154.07 price today to get back 100.00 in 98-years time. In a world of infinite possibilites, anything is probable… If you believe interest rates are going to remain negative for 100 years, I will even sing “The Sound of Music” as I sell you the bond.

According to the bankers who led the deal; investors bot the bonds because Austria is such a wonderful (and melodic) AAA/AA risk, the return meets long term investor yield targets, and it lengthening duration made the bonds very attractive on a relative basis to more risky names like Italy. It apparently appeals for long-term asset holders more concerned with their long liabilities than price. And a quick glance at the original Austria Century bonds launched in 2017, shows it’s performed very well, rising from 100 to 155 in price terms!

But with a 1.17% current yield if you buy it today! If I find out my pension provider has invested… I shall be concerned. My pension savings aren’t going to last long in such a low yield environment. A €1 million Euro pension pot invested in it gets you a €11,700 annual income!

Before I describe the new brilliant/insane investment deal I’ve come up – which I shall be negotiating with a number of European state agencies and supranationals this morning – first, let me delve back in time..

(Imagine hippy Time Tunnel music in the background, flashing lights, and… zzzaang .. we are back in 1988!)

Barry, Doug and I are crouched over one of very first Bloomberg machines and its neon orange screen. We’ve got a sheaf of documents in front of us, and I’m tip-exing out the name of one Swedish bank and replacing it with the name of a State Agency. We’ve just agreed a deal with a Japanese insurance company where they buy a bond issued by the Agency and we link it to performance of the Nikkei. We make money from the bond and the option. As the Nikkei climbed higher and higher, the deals went wonderfully well, right up to the moment they didn’t. The Nikkei crashed from its all-time-high of 38915 at the end of 1989 all the way down into the 15000, crashing to 7200 in 2009. Suffice to say, the insurance companies lost their money.

We used the same sheaf of documents for every deal. I reckoned we could save money, and charge issuers big arrangement fees, by setting up a programme for each issuer to launch lots of bonds off. It would cut the marginal cost of issuance. Others had the same idea, and within a few years the MTN market was born. But when it started it was very innovative and new.

I was having a drink with the young lawyer we used (he’s now very senior in London) and were discussing how the new “things” might work. I idly wondered about the potential for fraud. What if we set up a bond issuance programme for one of our most regular Scandinavian Agency issuers, and they funded themselves off it by launching lots and lots of small bonds. I wondered if they could lose track of them, or it could be abused if someone subverted the process. I imagined a scenario where investors bought a 30-year zero-coupon bond from the agency that the agency didn’t know about. What if someone – likely an insider at the issuer, but possibly a banker, or clearer – intercepted the proceeds of the bond before it went to the issuer. The first the issuer would ever know about it would be around now, in 2019, when the bond holder came knocking on the door asking for payment!

We agreed it would be very difficult to carry off such a heist, unless it was carefully planned and covered (including fooling the paying agents)… but it was theoretically possible. Interesting, there was a whiff of scandal at that same agency issuer; someone got “accidently shot”, while others quietly disappeared…

It all happened a Long, Long Time Ago…

That memory came back y’day while I was developing my brilliant new idea. With over $13 gazillion bonds new trading at negative yields, I called a large pension fund. What about a 30-year bond for quasi-state AAA risk at 0.20%? Now in a normal world, I should have been laughed at and told to go reproduce myself far away… But the fund manager thought it might be interesting.. “Tell me more”, he asked. So… we talked about zero coupon bonds, the Bund strip, negative yields, duration and convexity. I lost count of the number of times someone said.. “I’ll be retired by then”.

We came to the conclusion a Euro 100mm, 30-year Zero-Coupon private placement priced at 94% made excellent sense. At least it did till the fund’s compliance officer pointed out it might be quite illiquid and therefore the regulator, who is quite sniffy at these things at the moment, might object. So now we are trying to find another Euro 400mm of orders for our 30-year Zero Coupon. Interested? Give me a call.

Even better would be if we can convince the Germans to launch a 50 year Zero Coupon bond. After hours of diligent analysis and glass or two of Albarino, we concluded it would carry a positive yield and price around 99.50 so we give you 100.00 back in 2079. Fill my boots please!

It would be even better for my own pension fund.. if, say, (and just thinking aloud) the Germans issued it… but didn’t know they had.. if you get my drift… (Only joking… but… )

Ok… I admit.. it’s a thin news day ahead of the Xi-Trump summit tomorrow

Out of time, watching Osaka, and doing my day job..

Bill Blain, Shard Capital