Bonds often have maturities. The maturity date represents the specific date when the principal amount of the bond becomes due and is repaid to the bondholder. It also marks the end of the life of the bond. However, bonds are categorized according to their term or tenure, and some bonds last more than a lifetime. These are called perpetual bonds.
It is also important to note that these bonds are treated as equities rather than debts due to the absence of a maturity date or a specific date of redemption. Furthermore, because the stream of coupon payments is perpetual and they have no fixed repayment schedule, the entire transaction is similar to receiving dividend payments in stock investing.
Holding these bonds means receiving stable income from coupons throughout the lifetime of an investor. However, despite this enticing investment proposition, there is a drawback. These bonds might not provide maximum gains compared to other bonds with better coupon rates and yields. This article explains the advantages and disadvantages of perpetual bonds.
Pros: Advantages of Perpetual Bonds
Investing in perpetual bonds provides investors with a consistent and predictable source of income. These bonds, as the name implies, have no maturity date and can thus produce income for an indefinite period. This makes them particularly appealing to income-seeking investors looking for a consistent and reliable source of income.
These bonds are also less sensitive to changes in interest rates compared to other types of bonds. This makes them a good choice in a low-interest-rate environment. These bonds can also offer an added level of security because they are often issued by stable and reputable companies or governments. Below are the specific advantages of perpetual bonds:
• Stable Income and Long-Term Investment: Holding these bonds is ideal for income-seeking investors who want to receive predictable streams of cash at regular intervals and for an indefinite period while keeping their investments intact.
• Hassle-Free Moderate Investment Option: Investing in these bonds can also save investors time and effort. There is no need for them to spend time monitoring maturity dates and evaluating options for reinvestments.
• Cost-Effective Wealth Preservation Strategy: Another advantage of perpetual bonds is that purchasing and holding them can be part of wealth preservation. Investors do not need to be worried about reinvesting their principal.
• Flexible Structure and Step-Up Feature: Some issuers issue perpetual bonds that can be structured to allow flexible payment terms through payment deferrals or coupon rate adjustments. This is called a step-up feature.
• Theoretical Higher Investment Returns: These bonds might not have the same yields as callable bonds and high-yield bonds but the theoretical overall returns are often higher because bondholders would receive coupon payments forever.
Cons: Disadvantages of Perpetual Bonds
Perpetual bonds have some potential drawbacks that investors should consider. One major disadvantage is that they typically offer lower yields than fixed-rate bonds and callable bonds. Furthermore, because they have no maturity date, investors can be locked into receiving lower returns over the long term. This is unideal if interest rates rise.
Another potential drawback of these bonds is their complex valuation. These bonds are difficult to value in an accurate manner because their prices are more susceptible to fluctuations than bonds with shorter terms. These include short-term and medium-term bonds. The following are the specific disadvantages of perpetual bonds:
• Exposure to Risk From High Interest Rates: Holders of perpetual bonds are more exposed to the impacts of hikes in interest rates. Their investments will lose value if the interest rate rises above the coupon rates of their bonds.
• Diminished Value Due to High Inflation: The coupon payments from these bonds would remain the same throughout their lifetimes but the purchasing power of these payments will decrease and diminish as inflation rises.
• No Redemption and Repayment Obligation: Another notable disadvantage of perpetual bonds is that their respective issuers are not obligated to redeem them and return the invested principal to the bondholders.
• Has Lower Liquidity Than Other Bonds: Most bonds tend to be more liquid than stocks. This is not the case for perpetual bonds because of the absence of maturity dates. It is also more difficult to sell these bonds in the secondary market.
• Potential for Lower Investment Returns: These bonds still have the potential to provide lower investment gains compared to other investment options. Their returns would not be as high as more aggressive investments.
