The latest Treasury bill auctions have made it clear: the high yields offered by these debt securities will no longer be maintained. Since last June, all those who renew their 12-month letter must do so at a lower interest rate than the one they were receiving. The August 6 auction marked a before and after: the profitability of the 1-year debt of the Kingdom of Spain fell below 3%, something that had not happened since February 2023; the average interest rate was 2.95%. And just a few days ago, during the September 3 issue, exactly the same percentage was repeated. Everything indicates that from now on, Renewing the Letters to a higher performance will be an almost impossible mission. The 3.86% that the state was paying not so long ago, in October 2023, now seems a long way off; it is the highest interest rate since the European peripheral debt crisis of 2012.
But the fixed income landscape has changed rapidly. We are in a period of change in monetary policies; in Europe, the ECB already lowered its rates in June – for the first time in eight years – and the market is pricing in a first cut in the United States in September. This new reality forces the conservative investor, the one who favors fixed income securities the most, to make decisions. What are your options if you have to renew your letters? The investor returns from vacation without the security of obtaining a “guaranteed” return of 3%.
The experts consulted agree that Letters with shorter terms should be avoided.although currently they give more profitability. “They are today’s bread and tomorrow’s hunger,” summarizes Félix López, managing partner of atl Capital Gestión. “Many clients ask us if it is wise to go to Letters at 6 months, which offer 3.20%; The problem is that within 6 months they will not be able to renew them at 3.20%. From 6 months, the expected rate in Europe is around 2.75%, so at that point the renewal will probably be at a significantly lower rate. “In the end, you have to make a bet. It is true that we do not have absolute certainty about the evolution of rates. But at the moment, a very conservative client can be entitled to a slightly higher yield over 12 months. [a la de las Letras]since there is monetary funds including yields at 12 months, the discount commissions are significantly higher than those of 2.9%. You take on a small credit risk but, given the environment we are in, I think it is worth it.” This would be the most recommended option at the moment, instead of Letras. We also cannot forget that after the boom of the demand that these sovereign debt securities have received, “the Letters are expensive, and I do not consider that at this time they are the most appropriate asset for the conservative investor.”
The other option, according to atl partner, would be to increase the duration, and go to the 2 year bonus. “We are talking about 2.6% or 2.7% in the next two years, while rates in Europe are expected to be below or around 2.5% in about a year.”
For longer-term investors, there are other options, which involve increasing the duration somewhat and broadening the investment universe; this is not just very short-term sovereign debt, but also high-quality credit fixed income securities at slightly longer maturities. “The market offers significantly higher yields than Letters, with similar levels of credit risk in terms of rating“. Las Letras does not have a credit rating, but the Kingdom of Spain is a HAS- . “There are funds that have limits in terms of credit composition around HAS- which they offer, over periods of between 2 and 4 years, yields around 3.5%,” he explains.
“At present, The interesting thing is to guarantee you high rates and, at the same time, added value”, adds Víctor Alvargonzález, founding partner of the independent consultancy Nextep Finance. “This added value is very important. When people think of fixed income, they only think of the coupon; but with fixed income, just as you can lose a lot of money as happened in 2022, you can also make money.” In 2022, the price of global debt fell by more than 16%, driven by the rapid increase in rates by central banks. We are now at the opposite moment: central banks are starting to lower rates, which is triggering debt purchases in recent months, which is driving up bond prices. If I had to roll over a Treasury bond, Alvargonzález would consider “moving to 3-year government bonds, which can be purchased, like the Letters, directly at the Bank of Spain or online, with very reasonable commissions,” he points out. The yield on the 3-year bond is currently 2.56%. To this profitability “We must add the capital gains that you could generate within a year; if rates fall, “This 2.56% could easily be converted into 4%,” he estimates.
According to David Ardura, chief investment officer of Finaccess Value, the conservative investor has two options. The first is to do nothing; that is, to stay in letters or funds monetary policies over 12 months and accept that rates are lower and lower. The second option would be to “change the investor profile a little and assume some volatility, turning to other assets and longer durations, something that the conservative investor is not always comfortable with,” he warns. One of the alternatives they find is to “build a portfolio until maturity, either through a fund or through a bond portfolio… If you look, for example, at the 3-year corporate fixed income in Europewith a portfolio of triple-B “You can get a yield of over 3% with investment grade corporate bonds. I go to a maturity fund that gives me that yield and for 3 years I don’t touch my money,” Ardura says.
Rafael Valera, CEO and fixed income manager of Buy & Hold, considers that the alternative to Letters is Spanish sovereign debt, as well as investment-grade corporate debt. “Why look at the Portuguese bond? The Spanish bond gives more profitability,” he emphasizes. The fund manager B&H Debt highlights the advantage of funds over Letters, due to their tax deferral.The Letters mature and you pay taxes on that increase in assets, whereas in a fund, as long as you don’t sell, you don’t pay taxes.” B&H Debthe adds, could be an alternative for investors in letters, although its risk level is higher than that of Treasury securities. In any case, only invest in investment grade debt, that is, with a low probability of default; “It does not invest in subordinated debt, nor in promissory notes; but it has a longer duration, about 7 years, and you invest in credit,” warns Valera. This vehicle has appreciated by 3.5% so far in 2024.
