History is one of the best teachers, especially when it comes to investing. One of my favorite stories from financial history is about the world’s oldest bond, which offers valuable lessons for today’s investors.

In 1624, drifting sea ice on the river Lek in the Netherlands crashed into a dike, threatening the region around Amsterdam with flooding. To fund repairs, the local government and water board of Lekdijk Bovendams issued a bearer bond that paid 2.5% interest annually. Unlike modern bonds, this one had no maturity date. Whoever held the bond could collect interest indefinitely. Remarkably, one of these bonds survives today. It is owned by the New York Stock Exchange and still pays €13.61 in interest each year (about $21.60 Canadian dollars).

This piece of history has a lot to teach us. First, it highlights the traditional role bonds play in a portfolio, which is providing stability over time. Unlike stocks, which represent ownership in a company and can fluctuate in value with changes in profits, bonds are essentially loans to the borrower. As long as the borrower continues to pay interest, the bond maintains its value, as demonstrated by this centuries-old example.

Another key lesson is the importance of understanding exactly what you are investing in. A big influence on the value of a bond is the reliability of the borrower, or counterparty. Governments are generally more stable than companies because they can raise revenue through taxes to make interest payments, but even they are not without risk. For example, Argentina has defaulted on its debt nine times and currently holds a CCC+ or “junk” credit rating.¹ In contrast, it is remarkable that the Dutch authorities have continued to pay interest on their debt for nearly four centuries. This highlights why it is essential to carefully assess the financial strength of any entity you invest in.

Finally, there is the question of value. What would a bond like the Lekdijk Bovendams be worth today? Most of its value comes from its status as an antique artifact; in fact, it was sold by Christie’s auction house in 2000 for $47,000. We can also estimate its value as a financial asset using a straightforward formula. This bond is a perpetuity, meaning it pays a fixed amount indefinitely. Its value is simply the annual payment divided by the current market interest rate. With an annual payment of $21.60 and current 10-year Canadian government bond yields of 3.79%, the bond’s fair value would be about $569. This shows that by looking at an asset’s cash flows and the current economic environment, you can estimate its fundamental value. However, market prices don’t always match, especially in the short term, as they can be influenced by investor excitement or emotional factors. 

The world’s oldest bond continues to provide modern investors with insights into the role of bonds in a portfolio, the importance of understanding counterparties, and methods for valuing assets.

Stay disciplined,

-Andrew

 

Sources: 1) S&P Global Ratings, Council on Foreign Relations

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Andrew Pittet is an Investment Advisor with CIBC Wood Gundy in Calgary. The views of Andrew Pittet do not necessarily reflect those of CIBC World Markets Inc.

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