Bank vs government bonds: two ways of “loaning” in comparison
Second leg of the journey between investment instruments comparable to P2P loaning
Second leg of our journey to discover the pros and cons of the marketplace loaning compared to comparable investment instruments. Today the subject of the analysis will be the government bonds , recipients of faithful love from the Italians, not surprisingly known also as the Bot-people in their role as investors.
Government bonds are debt securities issued by a state that, in a nutshell, asks the indistinct public to finance it in exchange for an interest, which will correspond over time. The classic adage that concerns the tool is that it is risk free, that is risk-free – an adage that is not necessarily more so adherent to reality since 2009, the year of the explosion of the first sovereign debt crisis in Europe, a crisis in which government bonds were involved with the insolvency of unsuspecting nations belonging to the EU and that therefore should have been within the security parameters regarding the debt and deficit established by the Maastricht Treaty. A bubo that has discovered a nerve in the Western world: that the debt-to-GDP ratios are all over 100% against the 60% required by the Eurozone rules .
Today, since the crisis we are emerging, not only government bonds are no longer considered risk-free, but they do not do much, and have been for a long time in the order of zero point: they have made almost nothing.
But let’s go in order and try to understand better what we are talking about.
Government bonds are securities that a State issues to finance itself and obtain the resources necessary to fulfill its duties of producing services such as education, health and defense. These are bonds: that is a loan that entitles those who subscribe to the repayment of capital plus interest, which can be paid through the detachment of periodic coupons or through the issue discount, which is defined as the difference between issue price and price at the end of the security. Government bonds may have a maturity between 3 months and 50 years. The Italian government bonds that interest us here are issued periodically by the Ministry of the Economy and Finance and their duration and interests are the categories on which they can be classified. You switch from BOTs (Ordinary Treasury Bonds), which have a duration of 3 to 12 months and are zero coupons (do not correspond to coupons) to the Treasury Credit Certificates (CCT) and the Zero Coupon Treasury Certificates (CTZ) : respectively, the first 7-year maturity with semi-annual coupons at variable rates and the latter with a maturity of 24 months and without coupons. Until the Poliennial Treasury Bonds (BTP) with a duration of 3, 5, 10, 15, 30 and 50 years and fixed coupons every six months.
Recently, the Italian BTPs have been launched, with a duration of 4, 6 or 8 years and annual coupons paid every six months and there are inflation-linked forms, which provide that capital and half-yearly coupons are revalued on the basis of price changes.
In common with the product of Bank the government bonds have the nature of loans: only in our case the sums lent are intended for SMEs, while in the case of BOT, CCT and BTP the recipient of the loan, as widely explained, it’s Italy. Our product can be purchased online through a very simple registration procedure starting from the home of the site, it does not provide for intermediation of third parties, although it is subject to internal control and to the supervision of Consob and Bankitalia. Government bonds can be purchased at auction at the primary market or on the secondary market, which in the case of government bonds is the MOT, managed by Borsa Italiana. In both cases, securities must be purchased through a bank or a financial intermediary, with the payment of commissions that are higher when operating in the secondary market. Bank provides a single commission equal to 1% of the amount invested, but if you choose to go to the managed portfolio, built by us with a diversification in the order of 1%, it is lowered proportionally to the extent of the investment. Even our securities are resold on the secondary market to other loaners.
PERFORMANCE and Taxation
The yield on government bonds, we mentioned at the beginning, is the sore point of this instrument. In the course of our monthly survey of BTPs with a five-year maturity, we observed that the expected coupon is 0.95%, equal to a return net of the preferential tax rate of 12.5% of euro 83 on a capital invested 10 thousand euros . This is the sum that the investor would receive at the end of the life of the security, so only if he held it in his portfolio until maturity. Normally, the return on BTP is much higher as the yield curve moves: a 30-year maturity will have a higher level of remuneration than one with a maturity of 2 years, as the duration is directly correlated at risk.
On the secondary market it is possible to observe in real time the yield of the BTP: at the time of writing, for example, the ten-year BTP makes 1.91%, always gross of taxes and commissions. As our readers know and can observe from our periodic statistics , the performance of our instrument is constantly around 5% (gross of taxes, but net of the Protection Fund effect, which covers any outstanding loans).
The last point leads us directly to the question of risk. Whether it is for loans granted by Bank, or for BTPs, it lies in the possibility that the applicant is insolvent, or not repay his loaner. The important aspect is the mitigation of the risk assumed. In the case of Bank the investments are distributed on highly diversified portfolios and the SMEs are selected with very stringent rules which we have also recently discussed . The risk is also mitigated by the Protection Fund, the treasure that companies pay to cover any outstanding payments.
The risk of state insolvency is decidedly residual: it presupposes the failure of a State, which is, for obvious reasons, very unlikely. Not impossible, however, as history teaches: it happened on the occasion of the Argentinian default of 2001 and even closer to us, with Greece in 2015. With painful consequence in terms of losses for those who had bought the relative sovereign bonds.