Are Bond Buyers This Crazy?

Scared investors are buying bonds faster than crazed Black Friday shoppers going after the last Tickle Me Elmo in the store. So it's no surprise that Wall Street is in a hurry to deliver more of the goods. But are the bonds Wall Street wants to sell you really a smart investment?

Going long
The Wall Street Journal reported earlier this week that investment bankers are gauging interest in bonds with a 100-year maturity, also known as century bonds. Given the nearly unprecedented demand for corporate bonds, many of which carry significantly higher yields than the red-hot Treasury market are offering right now, smart companies have to consider whether locking in relatively low rates into the 22nd century is the best way to raise capital right now.

At first glance, you might wonder why anyone would be interested in buying a century bond. After all, it's highly unlikely that any adult investors will live long enough to see them mature. Even if they did, you can bet that the purchasing power of each $1,000 bond will erode to virtually nothing by the time 2110 rolls around -- assuming the company you invest in is still around to pay it.

According to WSJ, many companies have lengthened the maturities on their new bonds to take advantage of low rates. While supplies of three-year corporate bonds have been cut in half since last year, 30-year bond issuance is up 30%. So there's reason to believe that if new century bonds are ever likely to come out again, now's just about the best chance to see them.

How will they perform?
This wouldn't be the first time that companies have issued century bonds. Walt Disney (NYSE: DIS) and Coca-Cola (NYSE: KO) issued 100-year bonds back in 1993, when a flat yield curve made it extremely inexpensive to lengthen maturities from 2023 to 2093. Another set of lending occurred later in the 1990s, with several other issuers taking the opportunity to lend long.

The big question, of course, is how investors in century bonds can expect to do over time. For some insight, let's take a closer look at a few of those issues from the 1990s and see a how they've performed over time:

Source: E*TRADE Financial as of market close on Aug. 25. Current price and yield based on midpoint between bid and ask prices.

Notice that despite the favorable conditions the bond market was offering back then, some of these bonds have turned out to be good investments. The continuing bull market in bonds since these century bonds were issued has pushed the higher quality bonds upward in price, in some cases significantly. Meanwhile, those companies that have seen drops in their credit ratings since they issued these bonds have in seen some substantial losses, as investors demand higher rates to offset the greater risk of default.

Also, the long maturity of these bonds shows just how volatile long-dated bonds are. A rise of less than 1.75 percentage points in yield pushed the value of the Motorola bonds down almost 25%, while a drop of less than 2 percentage points sent the Coke bonds up nearly 35%.

Don't be a crazy bond buyer
There are a few institutional investors, such as pension funds and insurance companies, for which committing money for 100 years makes financial sense. When you have obligations that may not come due for 50 years or more, century bonds are sometimes your only choice to lock in a fixed return throughout that period.

But for the average investor, betting on the illiquid century-bond market solely as an interest rate play just doesn't make sense. For most investors, 30 years is more than long enough to give you the bond market exposure you need.

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