Investors, Issuers Plan for 2112 With 'Century Bonds'

NEW YORK ( TheStreet) -- Investors are starting to make trades that prepare themselves for the 22nd century amid uncertainty about the U.S. economy, the direction of interest rates and the sustainability of once mighty industries.

Will railroads, Coca Cola ( KO) drinks, Disney ( DIS) features and IBM ( IBM) IT systems be around when the 21st century draws to a close? Previous investor bets on those companies' bonds that expire at the end of the century say "yes."

Top U.S. colleges like the University of Pennsylvania are using current market worries to plan for a century of needs by selling 100-year bonds at what may amount to the cheapest financings in history. While retirement and college savers may find little benefit in those bonds, understanding the market for them may clear the air on how to navigate the investing risks that linger after the crisis.
University of Pennsylvania takes a look at "century bonds"

In March, the University of Pennsylvania sold $300 million in bonds that expire in 2112 at what may be a cheap financing for the record books. The bonds carry an interest rate of 4.674%, roughly 1.5% above the 30-year U.S. Treasury bond and less than a previous 100-year bond sold by the California Institute of Technology at an interest rate of 4.744% in November, which the school said was the lowest ever rate at the time.

In fact, for the University of Pennsylvania, the bond may one day be seen as a money maker. The university's Treasurer Stephen D. Golding calculates that if UPenn were to return 6% annually on its endowment for the next 100-years, slightly beating the 5.3% annual return of the Dow Jones Industrial Average during the 20th century, it would need to set aside just $884,168 to repay the $300 million borrowing - near-free money, when excluding interest payments.

But Golding and prospective buyers of UPenn's 100-year debt don't see it that way. Instead, they see a recent surge in "century bonds" as a way to make plans that resolve financial challenges far beyond the current uncertainty over whether a 2012 stock surge and signs of economic recovery mark an end to a 30-year bull market in bonds.

"I think we are in an aberration right now," says Golding of current interest rates that put the 10-year U.S. Treasury yield at just 2%. After watching peer institutions like Tufts University, Ohio State University and the University of Southern California take advantage of low rates to finance expenditures, Golding says UPenn entered the "century bond" market to invest in hard to fund building modernization and energy efficiency projects that will yield cost savings.

Still, Golding downplays the notion that UPenn caught a historic low yield, which may make the borrowing virtually free. "It's not about trying to time the market, but trying to catch the market in a general condition that makes sense from a cost of capital perspective."

Yields paid by the likes of UPenn signal that such conditions are an opportunity, even if investors aren't trying to plan for an interest rate nadir. "From an insurance company perspective, century bonds are interesting for some of our longer term products like long-term care," says Dan Sheehan a senior vice president of asset manangement at Genworth Financial.

For Genworth, which funds near perpetual healthcare and AARP- based insurance policies, the investments yield more than risk free assets like cash or U.S. Treasuries, with added benefits. "There is no question that the high credit quality is adding to the diversification of your portfolio," says Sheehan, who notes that Genworth has invested in MIT, USC, Tufts and Ohio State bonds. While rated at or near AAA, the bonds carry equivalent yields as 30-year bonds of companies with a much higher risk.

In considering 100-year bonds, Sheehan's goal of finding investments to outperform some market opportunities and lower other portfolio risks has a wider investor relevance. Using a similar focus, Warren Buffett has famously weathered the extreme market volatility of recent years to reposition his investments of Berkshire Hathaway's ( BRK.A) for what he expects will be a long run of above average returns.

While Buffett's current focus is on stock investments and he's recently called bonds "among the most dangerous of assets" as a result of risks like inflation, he and 100-year bond investors are similarly focused on investing in high quality institutions even in volatile markets.

Through the crisis, investments in companies with sound long-term prospects has Buffett poised to reap big dividend and share buyback profits, in addition to possible investment gains. It should come as no surprise that that the "Oracle of Omaha's" largest investments like IBM, Coca Cola and Burlington Northern Santa Fe are "century bond" issuers. Buffett's record shows that a focus on high quality investments with above market dividend or coupon potential can free investors from obsessing over short-term market swings, to their benefit.

A flurry of "century bonds" issued by universities in the last 12 months shows that bond market pros can also invest, even if they aren't ready to call an interest rate bottom. "The scenario of an 100 basis point spread to Treasuries is probably more yield than you would get on a AA or A industrial 30 year bond," says Robert Tipp, the chief investment strategist for Prudential Fixed Income.

"Universities may have negative events befall them, but at this point, their outlook may look relatively stable to industrials where we regularly see huge changes that wreak havoc on their business models and credit quality," adds Tipp, noting the telecom, auto and industrial sectors.

If other universities take UPenn's bond issue as a reason to tap the 100-year market, investors may be best served viewing the rare-bond market phenomena as inspiration to continue the hunt for high quality and dividend yielding investment opportunities in other markets like stocks.

That's especially the case since bond yields are unlikely to surge anytime soon. "The 10-year Treasury yield is justified no matter how much people think rates are going to rise over the long term," says Tom Higgins the Global Macro Strategist for Standish Mellon Asset Management, a fixed income investor with $86 billion in assets under management. "The economy is still fragile and susceptible to shocks."

For more on Warren Buffett's investments, see why Wells Fargo may prove the "Oracle" right again. See 10 dividend stocks held by high rated fund managers for some investing ideas. Also see how to position for inflation for more on ways to stay ahead of the curve.

-- Written by Antoine Gara in New York