50y and 100y UST bonds, do you like it?

[Daal]

Mnuchin is starting to sound more serious about the possibility of huge duration bonds. I can see this being a very interesting way to decrease capital demands for people that need to hold a certain amount of bonds/duration

Lets say I estimate I need to have 20% of my portfolio allocated to the 30y UST bond. With an 100y bond, I might be able to only allocate ~6-8% (or something along those lines), freeing up 13% in cash (but retaining the same duration exposure). I then can use that cash for other purposes (like using to trade an uncorrelated trading strategy to the main portfolio). I will give up the sovereign yield on that 13%, but I also will earn more on the 6-8% as the yield will usually be higher on the 100y. So the "cost of borrowing" is even lower than the sovereign yield. It might be even better then using futures (with the implied repo rate) if the yield spread between the 100y vs 30y is large enough

What are the risks and drawbacks involved with this? I know that in certain tail events the long end actually does better relative to the middle and front end (and there is a paper saying that is pretty much what happened in Greece). So please, only comment if you truly know what you are talking about

 

[truetype]

need to have 20% of my portfolio allocated to the 30y UST bond. With an 100y bond, I might be able to only allocate ~6-8%

That's now how bond math works.

 

[Daal]

That's now how bond math works.

I'm estimating, the exact % can't be known now and its not the focus of my post

 

[Martinghoul]

If I am allowed comment...

It all depends on the price.

 

[Daal]

If I am allowed comment...

It all depends on the price.

Yes but the fact that they will issue it leads to the chance that the pricing would enable such scheme, if not now, perhaps at some point in the future. I'm not sure how is the global supply and demand for duration (CNBC said something about huge duration bonds in the UK yielding less than the 30y, or something like that) but it would be nice to have them around.

 

[Martinghoul]

Yes but the fact that they will issue it leads to the chance that the pricing would enable such scheme, if not now, perhaps at some point in the future. I'm not sure how is the global supply and demand for duration (CNBC said something about huge duration bonds in the UK yielding less than the 30y, or something like that) but it would be nice to have them around.

In these things, it's never clear what comes first: supply or demand. The reason the UK, and to a lesser extent some Eurozone sovereigns, have been able to issue such debt is that they have a captive audience, which are forced buyers. It remains to be seen how much appetite such investors would have for a 50y UST. It might be great, or it might end up a damp squib.

 

[sle]

Well, to start, you maximum duration is equal to 1/yield. At the yield of 3%, current 30 year has a duration of about 20. If you assume that term structure will be flat, perpetual duration will be 33, so the "savings" in terms of notional value are less than you think.

As Martinghoul rightly pointed out, it all depends on the price.

 

[Daal]

Well, to start, you maximum duration is equal to 1/yield. At the yield of 3%, current 30 year has a duration of about 20. If you assume that term structure will be flat, perpetual duration will be 33, so the "savings" in terms of notional value are less than you think.

As Martinghoul rightly pointed out, it all depends on the price.

It might be more than just savings.

Correct me if I'm wrong but one advantage of these bonds is that they protect the buyer against a rise in short-term rates, at least relative to using futures. The futures buyer is short the repo rate (and has to pay commissions, bid ask spreads and waste his time during roll overs). If that rises more than the market thinks it will, he is screwed. The huge duration bonds don't get hurt by this (as much), i think it even benefits (as the 10y gets killed, its duration falls so the duration ratio changes and allows the guy on the 100y to sell some and free up even more cash to retain the same duration exposure). I'm assuming that spike in rates hurts the middle end more than the long end assuming people didn't lose the confidence in the central bank (which should be most of the time)

On the other hand, if the back end implodes relative to the 10y, then the 100y will get hurt more. So its a trade off.
Is this correct?

 

[sle]

Well, you carry more duration so there are risks that come with it. You get partially compensated for those risks by being longer convexity.

 

[Daal]

I'm referring here to scenario where someone has 20% of money in bonds and that person wants to free some of that cash to trade other things. One solution is to buy a little bit huge duration bonds (and the amount is set by the duration ratio) and use the free cash to do other things. The other solution is to, instead of getting the exposure through bonds, to get it through futures, then use the freed up cash to do other things with it.

The advantage of using huge duration bonds is that if short-term rates go to the moon (so, more than whats implied by the curve), you are 'protected' against it because you are not rolling over futures. On the other hand, if short-term rates surprise to the downside (a Japan/EU type scenario) and stay lower than what was implied by the yield curve, the futures guy will do better.
So there is a 'long' interest rate component in huge duration bonds (relative to futures), is this right or am I missing something?