Tufts 5% Century Bonds Now Yield 4%

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 |  Includes: KO, WIW
by: Charles Margolis

Four months ago Tufts University offered $250M in 5.017% century bonds (CUSIP 899043AA1) that Moody's rated Aa2. Currently the Tufts century bonds are priced at $126.22 (3.96% yield), a remarkable 26% increase in just sixteen weeks.

On July 30, 2012 a quantity of 500 Tufts century bonds were offered with a minimum purchase quantity of 1 bond. I had read about these bonds however had not seen them on the secondary market until this offering. So I bought a small position when the yield was just slightly over 4% earlier in the day.

Last week I profit took on lower credit quality Mattel (MAT) bonds, and after buying the Tufts bonds I profit took on Coca Cola (KO) stock. I considered the premium on the bonds acceptable because I used profit from other positions to compensate. Coca Cola (which is going to split on August 10th,) has about a 2.5% yield while the Tufts bonds have a 4% yield.

tufts 1854 Tufts campus in 1854

I spoke to Tufts treasury department this afternoon to inquire about call features. One of Tufts' treasurers stated that the bonds are "basically not callable for economic reasons" and there is a "make whole provision (so Tufts would) have to pay market plus rate to call them."

The Tufts University treasury e-mailed me a copy of the prospectus that states the bonds pay semi annual payments on April 15th and October 15th each year. The prospectus states:

The Bonds are subject to optional redemption prior to their stated maturity... at the "Make-Whole Redemption Price," which is equal to the greater of (i) 100% of the principal amount the Bonds to be redeemed and (ii) the sum of the present values of the remaining scheduled payments of principal and interest to the maturity date of the Bonds to be redeemed, not including any portion of those payments of interest accrued and unpaid as of the date on which the Bonds are to be redeemed, discounted to the redemption date selected by the Institution on a semi-annual basis...

FOR ANY SALES MADE OUTSIDE THE UNITED STATES, THE MINIMUM PURCHASE AND TRADING AMOUNT IS 150 UNITS...

The Bonds are not subject to mandatory redemption by sinking fund installments.

Peace and Light

Tufts University was founded on 20 acres of land donated by successful brick maker Charles Tufts in 1852. The acceptance rate is currently 21% and tuition is $43,688 per year. The university's motto is "Peace and Light."

Tufts has about 9,500 students and last year around 37% of Tufts students received grants based on financial need. Tufts is rated Aa2 by Moody's and has an endowment of $1.4B.

  • P.T. Barnum donated $50,000 to Tufts ($1,136,269 2009 U.S. dollars,) in 1883 and served on the board. He is the reason why Jumbo the elephant is the Tufts mascot.
  • "Tufts College Medical School came into official existence on August 22, 1893, by unanimous vote of the Trustees."
  • "In 1875-76 the combined tuition and incidentals fee reached $74... Only two years later the combined fees were increased to $100."

Tufts University Campus aerial view

Click to enlarge

The prospectus details the total amount of payments Tufts should pay each year and importantly a new tax consideration for bond holders' non-IRA accounts:

Interest payable on the Bonds in the fiscal year ending June 30, 2013 will be $13,099,944.44, and $12,542,500 in each fiscal year thereafter.

Medicare Tax on Unearned Income. The Health Care and Education Reconciliation Act of 2010 (P.L. 111- 152) requires certain U.S. Holders that are individuals, estates or trusts to pay an additional 3.8% tax on, among other things, interest and gains from the sale or other disposition of the Bonds for taxable years beginning after December 31, 2012.

Inflation & Purchasing Power

Tuft's executive vice president Patricia Campbell explained that the reason the University chose to issue these bonds was to "hedge against inflation."

The bond is a taxable debt instrument, which gives the university more flexibility in how the funds are used than tax-exempt bonds, says Campbell. If this financing opportunity hadn't arisen, the university would likely have issued a series of smaller, tax-exempt bonds to pay for the planned capital improvements, she says.

When rates go up the price of these bonds will go down, and when 30 yr. rates approach 5% the Tufts bonds will go under par (because they have a 5% coupon and are much longer term bonds.) Additionally as the value of the dollar goes down, due to inflation, the purchasing power of the income produced will be less. For instance P.T. Barnum's $50,000 gift to Tufts in 1883 would have been equivalent to over $1,000,000 in today's dollars.

So it is important to consider a strategy to prepare for inflation and a decrease in purchasing power.

An Income Strategy

The goal of the strategy is to try to raise the overall yield. For example consider taking the income from the Tufts bonds and going into an inflation protected CEF, like Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW) and Coca Cola for the next 50 years. Here is an example schedule for a $250,000 portfolio that buys 2 Tufts century bonds:

$250,000 portfolio in 2012 buys 2 Tufts century bonds Use of Tufts century bond income though 2060
2012-2019
  • After first three semi annual coupon payments buy Western Asset/Claymore Inflation Linked Opportunities and Income Fund.
  • After second three semi annual coupon payments buy shares of Coca Cola (also consider one other quality equity position to alternate every 6 coupon payments.)
  • Repeat for remaining 9 semi annual payments through end of the decade.
2020-2029
  • Every 3 coupon payments continue to alternatively buy income funds and shares of Coca Cola.
  • Every 6 coupon payments consider one quality alternative to Coca Cola and the income fund.
2030-2039
  • Every 3 coupon payments continue to alternatively buy income funds and shares of Coca Cola.
  • Every 6 coupon payments consider one quality alternative to Coca Cola and the income fund.
2040-2049
  • Every 3 coupon payments continue to alternatively buy income funds and shares of Coca Cola.
  • Every 6 coupon payments consider one quality alternative to Coca Cola and the income fund.
2050-2059
  • Every 3 coupon payments continue to alternatively buy income funds and shares of Coca Cola.
  • Every 6 coupon payments consider one quality alternative to Coca Cola and the income fund.
Click to enlarge

If the income fund you go into does not perform well, or the stock does not perform well the yield would be less. However the structure of a corporate bond should allow you to continue implementing this strategy every year or two, once you have enough cash (Tufts century bond fixed income) to invest.

Also consider the fact that there are higher yielding Aa2 bonds on the market such as the 4.69% Bowdoin College century bonds; so you might prefer the higher yield. Those bonds are also closer to par, however when rates go up both the Tufts and Bowdoin bonds will lose value. This is a good reason to know about them, not buy them, and keep them in your list of securities to consider at better price levels and higher yields.

It is important to note that a total loss or default on the bonds should not severely damage the overall integrity of the example portfolio. Because the allocation is 1% or less. While it would not be wise to recommend an over 1% allocation, because of the inflation and purchasing power worries, a small investment and strategy using a quality corporate bond has the ability to enhance a financial portfolio.

At the current price it should take five years for the fixed income from the Tufts century bonds to recoup the premium on their own. However with a strategy you can attempt to raise the overall yield. Investors who are considering Tufts bonds should call your brokerage's bond desk and ask them to put a bid out, in hopes of attaining a lower price.

If you have any additional considerations on the Tufts century bonds and this strategy please leave a comment below.

Disclosure: I am long KO, WIW.

Additional disclosure: I am long TUFTS UNIVERSITY BD 2012A 5.017% 4/15/2112