So much for dry January. Let’s reflect on the BLOCKBUSTER and RECORD-BREAKING bids we’ve seen for European sovereign bond sales this year.
It’s been fertile ground for reporters. Spain received a scorching €138bn of orders for a €15bn sale “the highest amount ever bid for a bond sale,” reported main FT (ahem). A Belgian bond, a dual-tranche offering of notes from Italy and two UK debt sales all saw “historic” order books, wrote Bloomberg.
Of some €90bn European government bonds sold via syndication so far this year — according to our own totting up on the Bloomberg Terminal — issuers received a stonking €872bn of bids.
This provides great optics for debt offices and banks tasked with offloading huge volumes of debt on behalf of countries with daunting borrowing needs.
But it makes you wonder — if so many more investors wanted bonds than received them, why haven’t they sold more? And did they get taxpayers the best possible price?
The reality is, marketing aside, the size of an order book is far from a true reflection of demand. Here’s how it works.
Job number one for debt offices is to sell debt at the best possible price for their respective taxpayers (while also maintaining a functioning market across the yield curve). In Europe, unlike the US, these offices sometimes employ banks to sell debt for them via so-called syndications. These are announced at relatively short notice, as opposed to auctions which run to regular schedules.
Syndications are a more opportunistic way of issuing large volumes of debt quickly and have been particularly popular this year as European countries rush to sell bonds.
Banks, which are paid a chunky fee to run the syndication, will go out to different investors to take the market’s temperature and drum up demand. While their focus is on how the yield of a new bond compares with neighbouring bonds — known as the ‘spread’ — they also care about the “quality” of the order book, because they don’t want a whole load of buyers who will immediately sell the bonds, likely pushing up the cost of future bond sales.
‘Real money’ asset managers buying on behalf of pension schemes (or, in some cases, pension schemes themselves) are the preferred buyers as they tend to have liability matching need for the bonds, so they tend to get the highest proportion of the orders they place. Let’s call it around 70 to 80 per cent of the amount requested.
Other real money managers that are more price sensitive likely get a bit less, because they might only show up on the day and hold on to the bonds if the market conditions are right. They could get around 50 to 60 per cent of their orders depending on the nature of their strategy and total bids at the syndication. Strategists also say debt offices are increasingly rewarding those who pre-commit to purchase.
At the bottom of the pile are the hedge funds and investment bank trading desks looking to flip the bonds for profit — not the long-term owners finance ministries want. So they might be given an allocation in the high single digits of their total orders (their provision of liquidity is helpful).
The trouble is that hedge funds know this, so they place inflated orders to improve their chances of getting what they want. (We say trouble, it could be that overbidding doesn’t really matter . . . please share your thoughts below.) And more hedge funds are getting involved, as bonds finally provide decent returns and record amounts of fresh debt sales offer ample opportunity to profit from new issue discounts. Hence, the demand numbers go up — but it’s all a bit of a mirage.
The eurozone is on track to sell €680bn of debt this year net of redemptions and European Central Bank purchase programmes, up 7 per cent from 2023, according to the investment arm of Italian insurer Generali. In the UK, officials estimated in November that the government’s gross financing requirements would be £277bn in the next financial year, about 16 per cent higher than total debt sales this year. And the Bank of England is in the process of offloading £100bn of gilts in the second year of its quantitative tightening programme.
Still, it’s good news that supply has so far been taken down pretty well this year. You can tell this from how bonds price and how they perform, so the true demand is there, probably because investors want to lock in yields well above levels of a few years ago, ahead of a slew of anticipated central bank rate cuts this year.
Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management, told MainFT:
There was an enormous consensus at the end of last year that supply was going to be problematic and the reality has been that the record supply in January has been absorbed extremely well. New issues initially came with large concessions that were tightened fairly aggressively as books were built.
But were they all tightened enough? Mike Riddell, a bond fund portfolio manager at Allianz Global Investors, noted the 10-year Spanish bond that was issued with a yield 0.09 percentage points higher than the 2033 bond previously in issue has now settled 0.055 percentage points higher.
“A big book mostly tells you that the bond being issued is coming a basis point or 2 cheap versus its immediate neighbours on the curve,” Riddell said.
Monitoring bond performance around syndications is also not as straightforward as it seems, because hedge funds can short the bonds in the days ahead of the sale to profit from the relative fall in bond prices that usually comes ahead of a big bond sale.
Closer to the issue time, they then look to buy bonds from banks to cover their shorts. This works well for the banks, who have been sold a pile of existing bonds with a similar maturity profile by investors who will receive the new ones at the syndications (a process known as ‘switching’, which strategists say has become increasingly popular). Through this, the banks paid the big bucks to run the process are able to offload some of the pricing risk to the hedge funds.
So who are the winners and losers? It looks like the hedge funds reap profits from syndications, with ‘real money’ managers perhaps getting smaller concessions than they used to. Banks also do well as they can de-risk the whole process and the DMO is happy because it is issuing huge sums smoothly, good for the taxpayer too, but the cost isn’t clear.
In practice, however, it’s all a bit more complicated . . . those who know more about this than me, any thoughts to mary.mcdougall@ft.com will be warmly received.
