Going Looooooooong with World Class University Debt

[thepupil]

There was recently a VIC writeup about dislocations in the muni bonds issued by the likes of Harvard, Princeton, Stanford, MIT, etc.

 

It mostly focused on front end muni paper, making a nice tax free 2 or 3% annualized for a few months as there was a liquidity squeeze in all parts of the bond market.

 

I am looking at this a bit differently and am more focused on the exceedingly long duration taxable corporate debt, quasi-perpetuals issued by these institutions as a convex Japanification/deflation hedge/juicy portion of my parents bond portfolio. there is also a short to intermediate term spread tightening trade once liquidity and normalization return to the bond market.

 

As an example. The taxable MASSIN 3.885% of 2116 (you read that maturity correctly), are offered at $116/3.33%, approximately 200 bps of credit/liquidity vs the 30 year to lend to MIT which has a) a top-performing endowment b) large property holdings c) diversified source of revenue (tuition, grants, summer camps, etc). It deserves its AAA credit, unlike say, Exxon Mobil whos 2050 paper offers the same yield.

 

I don't really think this is anyone's bag here, but I think this is actually decent risk/reward as part of an overall portfolio and a good way to safely (from a credit perspective) add duration at a substantial pick-up to a zero coupon or 30 year tsy bond. 200 bps is a good liquidity/credit risk pickup for quasi-soveriegn paper. If you want to get really fancy you could short 30 year futures against it and just be long the spread and make a nice return on tightening.

 

If I knew where the 30 year would be in 6 months, I would be sending this from my $10 million bugout compound. I don't. It could be at 3% and these could continue to trade 200 over (that would be bad), it could be at 3% and these trade 30 over (and you'd be flat) or it could be right where it is and these trade 50 over (lots of profit).

 

In this environment expect huge bid/asks tons of mark to market vol, but again once dealers are back at their desks, this stuff should tighten substantially.

 

 

Responses ahead of time:

 

1) what about inflation? that's not what this part of the portfolio is meant to protect against. inflation will destroy this. period.

 

2) don't you want the bonds part of the portfolio to be super liquid so you can use them for rebalancing? yes, and this isn't, you can't have this be all your bond portfolio

 

3) will fidelity/SChwab/ IBKR screw me on the bid ask? yes, as will any dealer. i suggest using IBKR to get a good idea of where actual bid/ask is. Fidelity is terrible and will trade against you or just not offer you the bond

 

4) I think lending at 3% for 100 years is insane..I agree, but so is lending at 1.3% for 30 years. Positive yielding dollar duration with virtually no credit risk is a scarce asset. It may not always be, rates can normalize. if you want to hedge duration you can, but that's a different trade with a new set of risks (you could lose money as sovereign trends to zero and credit spreads blow out)

 

 

 

[thepupil]

Picked up some Cal Tech 3.65% of 2119 today $105 / 3.5% yield.

 

These were issued in November 2019 when the 30 year was 2.2-2.4%. Now it is 1.13%.

 

Cal Tech has a $3 billion endowment, owns its campus near LA, is a top 10 university in the world by many measures, offers a huge value proposition to its students as they graduate with great jobs, conducts essential research. It deserves to exist.

 

Nice little addition to the japanification/long duration basket.

[thepupil]

Was able to buy some century bonds of a very prestigious liberal arts college today at a 4% yield, a credit/liquidity/century spread of 280 bps to the 30 year. low cost structure, $1mm endowment/student, good niche. sadly, their mascot may go extinct over the course of the bond's life.

 

PS: $100K of Caltech 3.65% of 2119 are offered $104/3.5% on Fidelity, have traded as low as par offering a juicy 3.65% for the privilege of lending your hard earned dough for a century. Go Orange Beavers?!?

[Jurgis]

I am not sure what you are doing, but you should keep doing it.

 

Peace brother.

[LC]

Loooooong indeed. Are you using them as a hedge against dropping rates i.e. duration trade?

[thepupil]

Yes, I think these are a good substitute (within limits) for long term treasuries as part of a duration barbell as part of a portfolio of cash and high quality fixed income as part of a retirement portfolio.

 

These are part businesses (purveyors of extremely sought after luxury goods, top 0-20% of society design their whole lives around their kids college admissions) part government contractor (research), part non taxable investment manager and real estate owner. They are some of the best and most durable businesees in the world. Only the crappiest of colleges have gone bust and I presume many will but not MIT Harvard Cal Tech etc.

 

I bought some shorter term Princeton muni’s for 2.4% that mature in 6-8 years the other day, that’s an amazing tax-equivalent yield, only snagged $10K of em. But as I said, I mostly like the long ones.

 

If the economy really takes a hit and stocks drop, rates go through zero, etc, I think the 30 year will be zero and these will be up 50-100%. LVMH can borrow for negative rates to buy Tiffany, why shouldn’t The best universities in the world trade to 2% yield  if dollar rates go the way of Euro/Yen.

 

Something that pays 3.5-4% (a reasonable withdrawal rate) in a asteady state and has huge convexity to a deflation / further rate drop has a role in a diversified portfolio in my opinion. I think it gets harder to hold at lower yields. An alternative to an annuity that goes away with death or whole life which is super illiquid and has no duration upside.

 

I owned a good bit of 30 year zero’s/regular tsy’s  for my parents when they were at 3% for the same reason (sold way too early).

 

Of course, they are illiquid (which may hurt the re-rateability). I only posted this after I’d bought a good slug for  for fear of inviting too much competition for odd lots. but whatever just put in your Fido fixed income screener for the highest yielding AAA and AA credits. You get Exxon and a bunch of world class universities.

 

they have huge downside of rates/inflation pick up.

 

I don’t want these to do really well because it means the corporate equities and real estate are probably getting destroyed.

 

 

[thepupil]

For those who don't like very long duration, but want to make safe tax advantaged yield from Princeton University.

 

https://finance.princeton.edu/sites/g/files/toruqf151/files/2019-09/Princeton.OS_.5.5.15.pdf

 

I have been buying various tenors of these issues. I don't love the longer one's because they are callable starting in 2025, and trade at pretty big premiums to par, creating what in the bond world we call "negative convexity" like resi MBS (rates go down, you get called and your bond is short, rates go up, you get extended and are lending long when you don't want to be).

 

So I have been a provider of liquidity in the 2023-2030 range at 1-2.5% yield to worst, federal and new jersey tax free.

 

you can view the whole curve easily by going on Fido and looking at the New Jersey Education issuer and sorting by rating. Princeton is at the top of the rating heap. It may have something to do with their $26 billion endowment, extremely wealthy donor base, high value proposition to customers, global brand, etc.

 

Go Tigers!

[beerbaron]

This might cool off some heads.

 

https://johnhcochrane.blogspot.com/2020/04/university-finances.html

 

BeerBaron

 

[benhacker]

Great thread. Thanks for the pointers pupil. You don’t want to go wild with these, but the convexity is real... damn.

[Libs]

 

 

Thought-provoking as usual, Pupil. Thanks.

 

Wouldn't one of these non-callable preferreds do the trick too?

 

WFC-L ( currently yielding around 5.5%)

BAC-L ( ditto)

 

This was a good primer on preferreds, by the way, from an old thread ( the writer recommends these two preferreds):

 

http://www.philosophicaleconomics.com/2017/03/a-value-opportunity-in-preferred-stocks/

[thepupil]

Not in my opinion. I have owned those successfully  in the past and don't think they are bad pieces of paper, but they are preferred stocks and not AAA/AA rated bonds. Both rating and instrument type matter in the world of insurance/pension investing (the natural buyers of super long duration, I presume). for the type of environment these things really go up on, bank spreads on junior instruments will be widening, not tightening. I don't know but are Unicredit or SocGen junior bonds at super low yields? probably yield more than LVMH or Nestle or sovereigns (or Berkshire's 0% JPY / Euro issues)

 

For the type of trade I'm proposing, you want something that is sovereign or quasi sovereign, something that is unquestionable. If Nestle or JNJ had 100 year paper yielding 3.5-4% in USD, I'd do the same, but Cal Tech or MIT works too.

 

I recall people telling me about their super cool Austrian 50-100 year bond shorts at 2%. Well the Republic of Austria 2.1% of 2117 are at 200 percent of par and up 100% since then while european equities are probably down since I had that convo.

 

Before being accused of subscribing to greater fool theory and not being a real value investor for not reading my Jim Grant and thinking that to lend at these rates is incredibly dumb, I remind you that this is a small part of a cash/fixed income pile that's mostly cash, the portfolio's total duration is less than AGG. On balance, I don't love to lend for nothing.

 

the hole in this argument is that these issues may be too small and illiquid to really get into the stratosphere. if that's the case, then my parents will just clip the 3.5-4% in their IRA's which covers the portfolio's withdrawal rate. if rates go up (particularly real rates) that would be a welcome relief after a decade of financial repression and poor low-risk compensation for savings and these will collapse in value. that would be great, but i have no reason to believe that will occur.

 

 

[thepupil]

bought some Bowdoin quasi-perps (2112 maturity) for $120 / 3.85% yield.

 

https://www.bowdoin.edu/finance/pdf/audited-financial-statements-fy19.pdf

 

since it's a liberal arts college rather than university/hospital. Bowdoin has a relatively simple balance sheet and cost structure. $2.3B of assets, ~$400mm or so of super long term debt, so this is 20% LTV type of paper. 

 

Bowdoin has a strong alumni network (Reed Hastings and Ken Chennault for example), an endowment of about $1mm / student, and will likely be around a long time.It is ranked the 6th best LAC in the country by US News. It is a business that deserves to exist and offers a good value proposition to its customers (graduates have the 25th highest earning power in the country, so it's no MIT, but it's no slouch either).

 

To earn a spread of over the 30y of 240 bps to lend to Bowdoin is not a terrible way to make close to 4% nominal and get long duration.

 

This can be barbelled with cash, to achieve a bond like yield and lots of convexity.

 

Go Polar Bears!