Issued in recent days, the BTP 2067 has certainly aroused the attention of Italian savers, historically accustomed to investing in domestic government bonds. And this is due both to the relatively high yield and to the very long maturity: half a century. This bond is well worth X-raying.
BTP 2067 IDENTIKIT
The new BTP (ISIN code IT0005217390) is very similar to others already in circulation, except for the very distant expiry: March 2067. It corresponds to a "modified duration" of 27 years – we will return to this subject shortly.
The annual coupon rate is 2,8% (but paid semi-annually, i.e. the coupon is 1,40% per semester), a number that can entice savers hungry for current income - quite a few, judging by the insane success of coupon products . The minimum denomination is equal to 1.000 euros, so that it is a security accessible to a large public of investors, in principle.
THE PERFORMANCE
The gross nominal yield at maturity is now equal to 2,9% per annum, more than double the yield of the 2067-year BTP, and will be forfeited with certainty - if the bond does not default - by any drawer investor (but, let's face it... how many savers intend to be drawer-keepers aiming for XNUMX? Certainly not me, who by then will probably be dead, according to the reliable Istat mortality tables).
In real terms, ie taking into account the erosive effect of inflation, a gross real yield of just under 1% will probably be obtained, assuming inflation around 2% (equal to the current objective of the European Central Bank). It's not too bad, after all: it is a real yield in line with long-term historical values for Europe, according to the Credit Suisse Global Investment Returns Yearbook 2016. However, it must be said that the BTP 1/3/2047, which expires twenty years earlier, yields 2,4% per annum gross. In short, one wonders whether, for a mere 0,4% of gross return, it makes sense to assume interest rate risk and counterparty risk vis-à-vis Italy for another 20 years.
THE RISK
The first thing to ask is: what happens if long-term interest rates suddenly move? How would the performance of this very long-term BTP be affected? The answer is in the following graph, which places possible shocks to interest rates on the horizontal axis and the consequences on the BTP in question, in terms of performance, on the vertical axis.
It's a reaction worthy of a black mamba. To illustrate, if long-term interest rates rose by 1%, this fifty-year BTP would lose an abundant 22% (technical note: here we see a beneficial effect of the convexity, which is relatively high). Even just a 0,5% hike in interest rates would cause this security to lose more than 12% in value. This is volatility, and possible losses, worthy of an equity investment. And that's just the interest rate risk.
Then there is the issue of counterparty risk: what is Italy's probability of default over such a period of time? Well, according to the CDS market, Italy's 10-year probability of default is 23% (source Bloomberg). Now, if you project this same default probability over a 50-year time span (it's a Markov chain, algebraic), you get a 72% default probability. Let me be clear, for me these are values that are placed in the domain of the absurd, I think the reality is a little less lugubrious than that.
But even if the probability of default in 5 years were half of what the CDS market shares today, i.e. just over 11%, it would still emerge that the probability of default in 50 years is around 45%. In short, spin it however you like, but over half a century the risk of default of a country like Italy cannot be ignored. Trivially, anything can happen, at a geopolitical level.
WHO IS THIS BTP FOR?
Definitely to the Treasury, which has perfectly seized the opportunity to refinance the long-term Italian public debt, making the most of the interest rates at their all-time lows. Truly a lectio magistralis in public debt management, a good move from which Italian governments will benefit from now to the future.
Issues of this type are then generally very convenient for institutional investors, such as insurance companies and pension funds, who have to deal with distant payments over time. Bonds like this are a breath of fresh air for insurers that have to pay long-term guaranteed minimums and are at risk of collapse if interest rates persist at these microscopic levels. In fact, against the 5 billion euro offered by the Treasury, the request (mainly from institutions) was over 18 billion euro, with a very high demand/supply ratio of 3,7.
Instead, as of today, I don't think it is a particularly interesting bond for savers: today's yield to maturity is at historically less than exciting levels, to put it mildly, given that other BTPs with shorter maturities offer similar yields, and the risks they're important. The security is appetizing for those who want to try their hand at trading, because with duration 27 the leverage effect on interest rate movements is enormous (as a first approximation, the performance of the bond is equal to: -modified duration x change in interest rate ). But it's a difficult and dangerous game: the volatility risk is as big as a condominium.
Let's put it this way: in my opinion, if and when there is an increase in interest rates (and consequently the price of this BTP will drop drastically), then it could be a long-term investment to be carefully considered.
From AdviseOnly blog.
