Perpetual bonds have become a popular investment among private investors. In this yield-hungry environment, investors have been enticed by the headline coupons offered by perpetual bonds. Private investors have bought a big chunk of some perpetual bonds - as much as 76 per cent of the recent perpetual issue by Cheung Kong (Holdings) went to private banks.
But many of the recent issues have immediately traded below par. Perpetual bonds issued in January by Agile Property, Cheung Kong and Reliance Industries have each lost 5 per cent to 10 per cent of their value.
Perpetual bonds have no maturity. Issuers usually have an option to "call", or buy back, a bond, but theoretically these issues can last forever, with investors never repaid their principal but forever reaping an annual interest payment.
Perpetual bonds are risky. The debt is typically subordinated. This means that investors are near the bottom of the hierarchy of lenders for repayment if an issuer defaults.
Investors at institutions typically won't buy perpetual bonds - they view them as too flaky and the coupons as too low for their risks. Issuers, as such, rely on private bank clients to sell their deals.
Perpetual bonds are also very sensitive to interest rate movements. Their price falls when interest rates rise to adjust for the fact that other investments have become available at a higher coupon. As it is, expectations are building that the United States will start raising interest rates as the economy recovers. These rate rises will affect perpetual bond prices.
To lure investors to invest in perpetuals, the instrument often offers protection against interest rate increases. For example, a rate reset might be offered. This means that, although there will be a stated coupon for the first few years, the coupon will be adjusted periodically as interest rates rise.
