No country is too objectionable or insecure for bond investors. The reason is bravado
Did you scamper to get your hands on last week’s Iraqi government bond issue? I guess not. But it was oversubscribed by around six times even though Iraq remains embroiled in a particularly nasty civil war while its one major asset – oil – suffers from the price downturn affecting all other producers.
Yet investors scrambled to get their hands on the Baghdad government’s first independent bond sale in more than a decade.
They were also keen to pour into recent bond issues by the Greek and Argentinian governments notwithstanding the fact that both countries are sitting on sovereign debt of mouth-watering proportions.
And if all this enthusiasm for sovereign debt issued by countries suffering from either or both intense political instability and, frankly, unpayable debt burdens, fails to convince you that some bond investors have an appetite for knife-edge risk, consider what happened last May when Goldman Sachs and Nomura – hardly to be described as back street banks – helped the crisis-enveloped government of Venezuela with a bond issue.
They got quite a lot of kickback for their de facto support of Nicolas Maduro’s government but the bonds got away without too much difficulty. Incidentally, if you fancy a punt on Venezuelan debt the government is currently looking at refinancing plans for already issued debt, so there’s still a chance to clamber aboard the Good Ship Maduro.
It seems that there is no country too objectionable or too insecure to deter bond investors. An old friend of mine who used to work for a blue blood London-based investment bank many years ago had the dubious pleasure of selling North Korean government sovereign debt. “Surely there were no takers?” I asked. “On the contrary, there were many,” he replied, adding that I would be surprised by who they were as they included big name investment companies.
Why do they do it? One reason is obvious: these risky bonds carry a high coupon. The yield on the Iraqi bond, for example, is 6.75 per cent, which is more or less the going rate for bonds in this higher risk category.
But are we really only talking about the classic risk/reward equation, which determines a lot of business decisions? I think not, and I am grateful to my ex-banker friend for his insight here. He said that many of his clients got quite a kick out of going into the badlands of the bond business. They saw themselves as being some kind of frontiersmen, demonstrating great bravery.
This sense of adventure was combined with the prudent awareness that investments in outlandish bonds comprised a tiny part of their portfolios, meaning that even if the gamble failed, losses would be relatively minor in the great order of things. Success, on the other hand, offered both monetary and reputational rewards.
Who said bonds were boring? Certainly not the investors who have been pouring into them, despite the fact that most of them offer tiny yields. This has encouraged governments, not least the US government, to issue new debt at a breathless pace. This month alone, US$62 billion of new government debt has been issued by the US Treasury despite the fact that the debt ceiling was hit in March. New debt was only issued after the government armed itself with so-called extraordinary measures to raise the ceiling higher.
Such is the enthusiasm for debt purchase that there is considerable talk of a debt bubble. Alan Greenspan, the former Fed chairman, recently complained that far too much debt is being issued and that “long term interest rates are much too low and therefore unsustainable”. When the worm turns, he expects it to do so rather quickly, leading to a bond price bubble that will take investors unawares.
Incidentally, it is not just governments who are busy shovelling out new debt issues; the private sector is also furiously issuing bonds. The corporate debt market is now valued at some US$9 trillion, almost double the level it was before the financial crisis.
So it appears that the gamblers who venture into the badlands of high-risk sovereign debt are not alone when it comes to bond risk as many other players are in the bond game at a time when investing in debt is far less boring than it used to be.
Whatever the facts of the matter, it is abundantly clear that interest rates simply cannot remain at current levels and are indeed inching upwards. This is pretty fascinating because traditionally the investment community looks to equities to produce crises. Bonds, if anything, are seen as a refuge in these circumstances. So, what happens when the refuge turns into being the source of contamination? Stand by for another onslaught of “interesting times”.