Perpetual bonds are a rare and interesting kind of debt not commonly seen by investors. The bonds, which have no date of maturity and pay a constant annual yield, are seeing a rise in popularity lately as investors frustrated by the low yield corporate debt market search for high yield alternatives.
So far in 2013, $28.9 billion worth of perpetual bonds were issued according to an article on institutionalinvestor.com. That is more than the value of perpetual bonds issued in 2010, 2011, and 2012 combined. The market for perpetual bonds has exploded, and it’s investor looking for alternative high yield bonds that are adding fuel to the fire.
David Einhorn's Greenlight Capital was down 0.1% for the first quarter, underperforming the S&P 500's 6.2% return. In their letter to investors, which was reviewed by ValueWalk, the Greenlight team said a lot happened during the first quarter even though they made just a handful of changes to the portfolio and essentially broke even. Q1 Read More
Perpetual bonds usually have a safety valve built into them that means they can not be called for a certain number of years after they are issues. After that period expires, however, most can be called at any time by the issuer. They’ve become a popular capital raising tool for companies that don’t want to liquify shareholders positions.
Perpetual bonds are also called hybrid bonds because of the similarities to equity. The boom in the current market for the asset class appears to be coming from Europe; these assets are tax deductible in many European countries, including France. This makes them an attractive way to raise capital.
Tax laws in the United States are not quite as hospitable to perpetual bonds. This means that while European firms are able to take advantage of the unique capital tool, U.S. firms are not able to compete as well in the area. U.S. perpetual bonds are usually aimed at retail investors in small issuances.
The major differences between perpetual bonds and equity are important ones. Perpetual bonds don’t offer any voting rights, and their value is not tied as directly to the fortunes of a company as equities are. In a case where default is unlikely, the bonds are valued on the value of their payout and face value. Payout value is difficult to discern because of the indeterminate nature of expiration dates.
The problem for yield-seeking investors is that these bonds are not, in case of a credit event, usually treated as a high priority, and are almost never on the same level as the firm’s senior bonds. Though yield may be 5 percent or higher for riskier firms, losses are more likely to arise in a crisis.
This is the same problem that afflicts a huge amount of the other debt instruments gaining popularity this year. Everything will go along swimmingly until there is a crisis. 2008 should have taught these lessons to investors, but when interest rates are so low that managers are struggling to meet their targets, the possibility of a crisis, even with Cyprus causing rifts in the world economy, seems miniscule.
Perpetual bonds are new, and they’re untested on a lot of fronts. Though the tool has been around since the eighteenth century, there is very little to tell how they’ll perform in the current market. Yield seeking investors may be in for a surprise when the next crisis rears its head.